Stock Market Glossary

Stock Market

A stock market, or (equity market), is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.

The size of the world stock market is estimated at about $51 trillion. The world derivatives market has been estimated at about $480 trillion face or nominal value, 30 times the size of the U.S. economy, and 12 times the size of the entire world economy. It must be noted though that the value of the derivatives market, because it is stated in terms of notional values, and cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. Many such relatively illiquid securities are valued as marked to model, rather than an actual market price.

The stocks are listed and traded on stock exchanges which are entities a corporation or mutual organization specialized in the business of bringing buyers and sellers of stocks and securities together. The stock market in the United States includes the trading of all securities listed on the NYSE, the NASDAQ, the Amex, as well as on the many regional exchanges, e.g. OTCBB and Pink Sheets. European examples of stock exchanges include the London Stock Exchange, the Deutsche Borse and the Paris Bourse, now part of Euronext.

Trading

Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. Their orders usually end up with a professional at a stock exchange, who executes the order.

Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders.

Actual trades are based on an auction market paradigm where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place on a first come first served basis if there are multiple bidders or askers at a given price.

The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace (virtual or real). The exchanges provide real-time trading information on the listed securities, facilitating price discovery.

The New York Stock Exchange is a physical exchange, also referred to as a listed exchange — only stocks listed with the exchange may be traded. Orders enter by way of exchange members and flow down to a specialist, who goes to the floor trading post to trade stock. The specialist's job is to match buy and sell orders using open outcry. If a spread exists, no trade immediately takes place--in this case the specialist should use his/her own resources (money or stock) to close the difference after his/her judged time. Once a trade has been made the details are reported on the "tape" and sent back to the brokerage firm, which then notifies the investor who placed the order. Although there is a significant amount of human contact in this process, computers play an important role, especially for so-called "program trading".

The NASDAQ is a virtual listed exchange, where all of the trading is done over a computer network. The process is similar to the New York Stock Exchange. However, buyers and sellers are electronically matched. One or more NASDAQ market makers will always provide a bid and ask price at which they will always purchase or sell 'their' stock. [1].

The Paris Bourse, now part of Euronext, is an order-driven, electronic stock exchange. It was automated in the late 1980s. Prior to the 1980s, it consisted of an open outcry exchange. Stockbrokers met on the trading floor or the Palais Brongniart. In 1986, the CATS trading system was introduced, and the order matching process was fully automated.

From time to time, active trading (especially in large blocks of securities) have moved away from the 'active' exchanges. Securities firms, led by UBS AG, Goldman Sachs Group Inc. and Credit Suisse Group, already steer 12 percent of U.S. security trades away from the exchanges to their internal systems. That share probably will increase to 18 percent by 2010 as more investment banks bypass the NYSE and NASDAQ and pair buyers and sellers of securities themselves, according to data compiled by Boston-based Aite Group LLC, a brokerage-industry consultant [citation needed].

Now that computers have eliminated the need for trading floors like the Big Board's, the balance of power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11 billion a year that institutional investors pay in trading commissions[citation needed].

Short Selling

In finance, short selling or "shorting" is the practice of selling securities the seller does not own, in the hope of repurchasing them later at a lower price. This is done in an attempt to profit from an expected decline in price of a security, such as a stock or a bond, in contrast to the ordinary investment practice, where an investor "goes long," purchasing a security in the hope the price will rise.

The term "short selling" or "being short" is often also used as a blanket term for all those strategies which allow an investor to gain from the decline in price of a security. Those strategies include buying options known as puts. A put option consists of the right to sell an asset at a given price; thus the owner of the option benefits when the market price of the asset falls. Similarly, a short position in a futures contract, or to be short a futures contract, means the holder of the position has an obligation to sell the underlying asset at a later date, to close out the position.

To profit from the stock price going down, short sellers can borrow a security and sell it, expecting that it will decrease in value so that they can buy it back at a lower price and keep the difference. The short seller owes their broker, who usually in turn has borrowed the shares from some other investor who is holding his shares long; the broker itself seldom actually purchases the shares to lend to the short seller.[1] The lender of the shares does not lose the right to sell the shares.

Short selling is the opposite of "going long." The short seller takes a fundamentally negative, or "bearish" stance, anticipating that the price of the shorted stock will fall (not rise as in long buying), and it will be possible to buy at a lower price whatever was sold, thereby making a profit ("selling high and buying low," to reverse the adage). The act of buying back the shares which were sold short is called 'covering the short'. Day traders and hedge funds often use short selling to allow them to profit on trading in stocks which they believe are overvalued, just as traditional long investors attempt to profit on stocks which are undervalued by buying those stocks.

In the U.S., in order to sell stocks short, the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. This is referred to as a "locate," and it is a legal requirement that U.S. regulated broker-dealers not permit their customers to short securities without first obtaining a locate. Brokers have a variety of means to borrow stocks in order to facilitate locates and make good delivery of the shorted security.

The vast majority of stock borrowed by U.S. brokers comes from loans made by the leading custody banks and fund management companies (see list below). Sometimes brokers are able to borrow stocks from their customers who own "long" positions. In these cases, if the customer has fully paid for the long position, the broker cannot borrow the security without the express permission of the customer, and the broker must provide the customer with collateral and pay a fee to the customer. In cases where the customer has not fully paid for the long position (meaning the customer borrowed money from the broker in order to finance the purchase of the security), the broker will not need to inform the customer that the long position is being used to effect delivery of another client's short sale.

Most brokers will allow retail customers to borrow shares to short a stock only if one of their own customers has purchased the stock on margin. Brokers will go through the "locate" process outside their own firm to obtain borrowed shares from other brokers only for their large institutional customers.

Stock exchanges such as the NYSE or the NASDAQ typically report the "short interest" of a stock, which gives the number of shares that have been sold short as a percent of the total float. Alternatively, these can also be expressed as the short interest ratio, which is the number of shares sold short as a multiple of the average daily volume. These can be useful tools to spot trends in stock price movements.

Margin Buying

Margin buying is buying securities with cash borrowed from a broker, using other securities as collateral. This has the effect of magnifying any profit or loss made on the securities. The securities serve as collateral for the loan. The net value, i.e. the difference between the value of the securities and the loan, is initially equal to the amount of one's own cash used. This difference has to stay above a minimum margin requirement. This is to protect the broker against a fall in the value of the securities to the point that they no longer cover the loan.

Some say that in the 1920s, margin requirements were loose. In other words, brokers required investors to put in very little of their own money. When stock markets plummeted, the net value of the positions rapidly fell below the minimum margin requirements, forcing investors to sell their positions. This is cited as a factor contributing to the Stock Market Crash of 1929, which in turn contributed to the Great Depression. However, as reported in Peter Rappoport and Eugene N. White's 1994 paper Was the Crash of 1929 Expected (http://www.jstor.org/stable/2117982), all sources indicate that beginning in either late 1928 or early 1929, "margin requirements began to rise to historic new levels. The typical peak rates on brokers' loans were 40-50 percent. Brokerage houses followed suit and demanded higher margin from investors."

Balance Sheet

In financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a company's financial condition.[1] Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time.

A company balance sheet has three parts: assets, liabilities and shareholders' equity. The main categories of assets are usually listed first and are followed by the liabilities. The difference between the assets and the liabilities is known as equity or the net assets or the net worth of the company; according to the accounting equation, net worth must equal assets minus liabilities.[2]

Another way to look at the same equation is that assets equals liabilities plus net worth. This is how a balance sheet is presented, with assets in one section and liabilities and net worth in the other section. The sum of these two sections must be equal; they must "balance".

Records of the values of each account or line in the balance sheet are usually maintained using a system of accounting known as the double-entry bookkeeping system.

A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand. However, real businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words: businesses have assets and so they can not, even if they want to, immediately turn these into cash at the end of each period. Real businesses owe money to suppliers and to tax authorities, and the proprietors do not withdraw all their original capital and profits at the end of each period. In other words businesses also have liabilities.

Dead Cat Bounce

A dead cat bounce is a term used by traders in the finance industry to describe a pattern wherein a spectacular decline in the price of a stock is immediately followed by a moderate and temporary rise before resuming its downward movement, with the connotation that the rise was not an indication of improving circumstances in the fundamentals of the stock. It is derived from the notion that "even a dead cat will bounce if it falls from a great height".

The phrase has been used on the trading floors for many years. However the earliest recorded use of the phrase dates from 1985 when the Singaporean and Malaysian stock markets bounced back after a hard fall during the recession of that year. Journalist Christopher Sherwell of the Financial Times reported a stock broker as saying the market rise was a "dead cat bounce".

The reasons for such a bounce can be technical, as investors may have standing orders to buy shorted stocks if they fall below a certain level or to cover certain option positions. Once those limits are reached, the buy orders are activated and the sudden rise in demand causes the price of the stock to rise as well. The bounce may also be the result of speculation. Since bounces often occur, traders buy into what they hope is the bottom of the market, expecting a bounce and thus making a quick profit. Thus, the very act of anticipating a bounce can create and magnify it.

A market rise after a sharp fall can only really be seen to be a "dead cat bounce" with the benefit of hindsight. If the stock starts to fall again in the following days and weeks, then it is a true dead cat bounce. If the market starts to climb again, it was not a bounce but a real bottom.

The phrase has also been used in politics in reference to primary election poll figures for United States presidential elections.[1]

Shareholders Equity

In accounting terms, after all liabilities are paid, ownership equity is the remaining interest in assets. If valuations placed on assets do not exceed liabilities, negative equity exists.

Shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital employed) is this interest in remaining assets, spread among individual shareholders of common or preferred stock.

At the start of a business, owners put some funding into the business to finance assets. Businesses can be considered to be, for accounting purposes, sums of liabilities and assets; this is the accounting equation. After liabilities have been accounted for, the positive remainder is deemed the owner's interest in the business.

This definition is helpful when a business is not paying its bills and gets liquidated, wound up, put into receivership or bankruptcy. Then, a series of creditors, ranked in priority sequence, have the first claim on the proceeds (e.g. asset sales), and ownership equity is the last or residual claim against assets, paid only after all other creditors are paid. In such a case, creditors may not get enough money to pay their bills, and nothing is left over to reimburse owners' equity. Thus owners' equity is reduced to zero. Ownership equity is also known as risk capital, liable capital and equity.

Stock Exchange

A stock exchange, share market or bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for recordkeeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks (see stock valuation).

There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

Stock Market Index

A stock market index is a method of measuring a stock market as a whole. Many indices are compiled by news or financial services firms and are used to benchmark the performance of portfolios such as mutual funds.

Stock Market Bubble

A stock market bubble is a type of economic bubble taking place in stock markets when price of stocks rise and become overvalued by any measure of stock valuation.

The existence of stock market bubbles is at odds with the assumptions of efficient market theory which assumes rational investor behaviour. Behavioral finance theory attribute stock market bubbles to cognitive biases that lead to groupthink and herd behavior. Bubbles occur not only in real-world markets, with their inherent uncertainty and noise, but also in highly predictable experimental markets [1]. In the laboratory, uncertainty is eliminated and calculating the expected returns should be a simple mathematical exercise, because participants are endowed with assets that are defined to have a finite lifespan and a known probability distribution of dividends. Other theoretical explanations of stock market bubbles have suggested that they are rational [2], intrinsic [3], and contagious [4].

Stock Market Crash

A stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market. Crashes are driven by panic as much as by underlying economic factors. They often follow speculative stock market bubbles.

Stock market crashes are social phenomena where external economic events combine with crowd behavior and psychology in a positive feedback loop where selling by some market participants drives more market participants to sell. Generally speaking, crashes usually occur under the following conditions[citation needed]: a prolonged period of rising stock prices and excessive economic optimism, a market where Price to Earnings ratios exceed long-term averages, and extensive use of margin debt and leverage by market participants.

There is no numerically-specific definition of a crash but the term commonly applies to steep double-digit percentage losses in a stock market index over a period of several days. Crashes are often distinguished from bear markets by panic selling and abrupt, dramatic price declines. Bear markets are periods of declining stock market prices that are measured in months or years. While crashes are often associated with bear markets, they do not necessarily go hand in hand. The crash of 1987 for example did not lead to a bear market. Likewise, the Japanese Nikkei bear market of the 1990s occurred over several years without any notable crashes.

Price/Sales Ratio

Price-to-sales ratio, P/S ratio, or PSR, is a valuation metric for stocks. It is calculated by dividing the company's market cap by the company's revenue in the most recent fiscal year (or the most recent four fiscal quarters); or, equivalently, divide the per-share stock price by the per-share revenue.

The metric can be used to determine the value of a stock relative to its past performance. It may also be used to determine relative valuation of a sector or the market as a whole.

PSRs vary greatly from sector to sector, so they are most useful in comparing similar stocks within a sector or sub-sector. Also, since sales are less easy to manipulate as compared to earnings, price-sales ratios are more indicative of performance as compared to price-earnings ratios.

Common Stock

A voting share (also called common stock or ordinary share) is a stock giving a stockholder the right to vote on matters of corporate policy and the composition of the members of the board of directors.

Voting shares are in contrast to preferred shares, which may have different voting, dividend, or other rights.

Preferred Stock

Preferred stock, also called preferred shares or preference shares, is typically a higher ranking stock than voting shares, and its terms are negotiated between the corporation and the investor.

Preferred stock usually carry no voting rights,[1][2] but may carry superior priority over common stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend that is paid out prior to any dividends to common stock holders. Preferred stock may have a convertibility feature into common stock. Preferred stockholders will be paid out in assets before common stockholders and after debt holders in bankruptcy. Terms of the preferred stock are stated in a "Certificate of Designation".

Outstanding Stock

Shares outstanding are common shares that have been authorized, issued, and purchased by investors. They have voting rights and represent ownership in the corporation by the person or institution that holds the shares. They should be distinguished from treasury shares, which are common stock repurchased by the corporation. Treasury shares decrease outstanding shares.

Shares outstanding can be calculated as either basic or fully diluted, with the effect of such diluting securities as options or convertibles. Shares outstanding can be obtained from quarterly filings with the SEC.

Float

The free float of a public company is an estimate of the proportion of shares that are not held by large owners and that are not stock with sales restrictions (restricted stock that cannot be sold until they become unrestricted stock).

The free float or a public float is usually defined as being all shares held by investors other than:

    * shares held by owners owning more than 5% of all shares (those could be institutional investors, "strategic shareholders," founders, executives, and other insiders' holdings)
    * restricted stocks (granted to executives that can be, but don't have to be, registered insiders)
    * insider holdings (it is assumed that insiders hold stock for the very long term)

The free float is an important criterion[clarify] in quoting a share on the stock market.[citation needed]

To float a company means to list its shares on a public stock exchange through an initial public offering (or "flotation").

Market Capitalization

Market capitalization/capitalisation (aka market cap, mkt cap or capitalized/capitalised value) is a measurement of corporate or economic size equal to the share price times the number of shares outstanding of a public company. As owning stock represents owning the company, including all its assets, capitalization could represent the public opinion of a company's net worth and is a determining factor in stock valuation. Likewise, the capitalization of stock markets or economic regions may be compared to other economic indicators. The total market capitalization of all publicly traded companies in the world was US$51.2 trillion in July 2008.[1]

Valuation

Market capitalization represents the public consensus on the value of a company's equity. A corporation, including all of its assets, may be freely bought and sold through purchases and sales of stock, which will determine the price of the company's shares. Its market capitalization is this share price multiplied by the number of shares in issue, providing a total value for the company's shares and thus for the company as a whole.

Many companies have a dominant shareholder, which may be a government entity, a family, or another corporation. Many stock market indices such as the (S&P 500, Sensex, FTSE, DAX, Nikkei, Ibovespa, and MSCI) adjust for these by calculating on a "free float" basis, ie the market capitalization they use is the value of the publicly tradable part of the company.

Note that market capitalization is a market estimate of a company's value, based on perceived future prospects, economic and monetary conditions, and therefore largely independent of a company's history. Stock prices can also be moved by speculation about changes in expectations about profits or about mergers and acquisitions.

It is possible for stock markets to get caught up in an economic bubble, like the steep rise in valuation of technology stocks in the late 1990s followed by the dot-com crash in 2000. Speculation can affect any asset class, such as gold or real estate. In such events, valuations rise disproportionately to what many people would consider the fundamental value of the assets in question. In the case of stocks, this pushes up market capitalization in what might be called an "artificial" manner. Market capitalization is therefore only a rough measure of the true size of a market.

Shares Authorized

Shares authorized is the maximum number of shares that a company can issue. This number is specified in the company's articles of association but can be changed by shareholder approval. A company usually authorizes a higher number of shares than required to be able to issue stock in the future.

Market Maker

A market maker is a firm that quotes both a buy and a sell price in a financial instrument or commodity, hoping to make a profit on the turn or the bid/offer spread.

In foreign exchange trading, where most deals are conducted Over-the-Counter and are, therefore, completely virtual, the market maker sells to and buys from its clients. Hence, the client's loss and the spread is the market-maker firm's profit, which gets thus compensated for the effort of providing liquidity in a competitive market. This extra liquidity reduces transaction costs and therefore facilitates trades for the clients, who would otherwise have to accept a worse price or even not be able to trade at all. Most foreign exchange trading firms are market makers and so are many banks, although not in all currency markets.

Most stock exchanges operate on a matched bargain or order driven basis. In such a system there are no designated or official market makers, but market makers nevertheless exist. When a buyer's bid meets a seller's offer or vice versa, the stock exchange's matching system will decide that a deal has been executed.

In the United States, the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX), among others, have a single exchange member, known as the "specialist," who acts as the official market maker for a given security. In return for a) providing a required amount of liquidity to the security's market, b) taking the other side of trades when there are short-term buy-and-sell-side imbalances in customer orders, and c) attempting to prevent excess volatility, the specialist is granted various informational and trade execution advantages.

Other U.S. exchanges, most prominently the NASDAQ Stock Exchange, employ several competing official market makers in a security. These market makers are required to maintain two-sided markets during exchange hours and are obligated to buy and sell at their displayed bids and offers. They typically do not receive the trading advantages a specialist does, but they do get some, such as the ability to naked short a stock, i.e., selling it without borrowing it. In most situations, only official market makers are permitted to engage in naked shorting.

On the London Stock Exchange (LSE) there are official market makers for many securities (but not for shares in the largest and most heavily traded companies, which instead use an automated system called TradElect). Some of the LSE's member firms take on the obligation of always making a two way price in each of the stocks in which they make markets. It is their prices which are displayed on the Stock Exchange Automated Quotation system, and it is with them that ordinary stockbrokers generally have to deal when buying or selling stock on behalf of their clients.

Proponents of the official market making system claim market makers add to the liquidity and depth of the market by taking a short or long position for a time, thus assuming some risk, in return for hopefully making a small profit. On the LSE one can always buy and sell stock: each stock always has at least two market makers and they are obliged to deal.

This contrasts with some of the smaller order driven markets. On the JSE Securities Exchange, for example, it can be very difficult to determine at what price one would be able to buy or sell even a small block of any of the many illiquid stocks because there are often no buyers or sellers on the order board. However, there is no doubting the liquidity of the big order driven markets in the U.S.

Unofficial market makers are free to operate on order driven markets or, indeed, on the LSE. They do not have the obligation to always be making a two way price but they do not have the advantage that everyone must deal with them either.

Broker-Dealer

A broker-dealer is a company that trades securities for customers as well as for its own account. In the United States, a broker-dealer has to be registered with the Financial Industry Regulatory Authority. When executing trade orders on behalf of a customer, the institution is said to be acting as a broker. When executing trades for its own account, the institution is said to be acting as a dealer. Securities bought from clients or other firms in the capacity of dealer may be sold to clients or other firms acting again in the capacity of dealer, or they may become a part of the firm's holdings.

There are 2 types of broker dealers: introducing and clearing.

Earnings Per Share

Earnings per share (EPS) are the earnings returned on the initial investment amount.

In the US, the Financial Accounting Standards Board (FASB) requires companies' income statements to report EPS for each of the major categories of the income statement: continuing operations, discontinued operations, extraordinary items, and net income.

Book Value

In accounting, book value or carrying value is the value of an asset or according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. A company's book value is its total assets minus intangible assets and liabilities.[1][2] In the United Kingdom, the term net asset value may refer to the book value of a company.[3]

An asset's initial book value is its actual cash value or its acquisition cost. Cash assets are recorded or "booked" at actual cash value. Assets such as buildings, land and equipment are valued based on their acquisition cost, which includes the actual cash cost of the asset plus certain costs tied to the purchase of the asset, such as broker fees. Not all purchased items are recorded as assets; incidental supplies are recorded as expenses. Some assets might be recorded as current expenses for tax purposes. An example of this is assets purchased and expensed under Section 170 of the US tax code.[citation needed]

P/E ratio

The PEG ratio, Price/Earnings To Growth, is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company's expected growth.

The P/E ratio (price-to-earnings ratio) of a stock (also called its "earnings multiple", or simply "multiple", "P/E", or "PE") is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share.[1] A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios. The reciprocal of the PE ratio is known as the earnings yield.[2] The earnings yield is an estimate of expected return to be earned from holding the stock if we accept certain restrictive assumptions. [3]

The price per share (numerator) is the market price of a single share of the stock. The earnings per share (denominator) is the net income of the company for the most recent 12 month period (for "Trailing P/E" or "P/E ttm", which is most common), divided by number of shares outstanding. The P/E ratio can also be calculated by dividing the company's market capitalization by its total annual earnings.

For example, if stock A is trading at $24 and the earnings per share for the most recent 12 month period is $3, then stock A has a P/E ratio of 24/3 or 8. Put another way, the purchaser of stock A is paying $8 for every dollar of earnings. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as Not applicable or "N/A"); sometimes, however, a negative P/E ratio may be shown.

Most stocks trade between a 15-25 P/E ratio[4]. Stocks with higher earnings growth will have a higher P/E, and those with lower earnings growth will have a lower P/E. A ratio higher than 25 must have really good earnings or risk a drop in the stock price.

By comparing price and earnings per share for a company, one can analyze the market's stock valuation of a company and its shares relative to the income the company is actually generating.[citation needed] Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading.

PEG Ratio

PEG Ratio = Price/Earnings/Annual EPS Growth

A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive). A PEG ratio that approaches two or goes higher than 2 is believed to be too high. This means that the price paid appears to be much too high relative to the projected earnings growth.

PEG is a widely employed indicator of a stock's possible true value. The PEG ratio of 1 represents a fair trade-off between the values of cost and the values of growth, indicating that a stock is reasonably valued given the expected growth. Similar to PE ratios, a lower PEG means that the stock is undervalued more. It is favored by many over the price/earnings ratio because it also accounts for growth. If a company is growing at 30% a year, then the stock's P/E could be 30 to have a PEG of 1. PEG ratios between 1 and 2 are therefore considered to be in the range of normal values. A crude analysis suggests that companies with PEG values between 0 to 1 may provide higher returns[1].

The PEG ratio is commonly used and provided by various sources of financial and stock information. The PEG ratio, despite its wide use, is only a rule of thumb and has no accepted underlying mathematical basis. Its specific mathematical deficiency is explained here.

The PEG ratio's validity at extremes in particular (when used, for example, with low-growth companies) is highly questionable. It is generally only applied to so-called growth companies (those growing earnings significantly faster than the market).

When the PEG is quoted in public sources it may not be clear whether the earnings used in calculating the PEG is the past year's EPS or the expected future year's EPS; it is considered preferable to use the expected future growth rate.

Price/cash flow Ratio

The price/cash flow ratio (also called price-to-cash flow ratio or P/CF), is a ratio used to compare a company's market value to its cash flow. It is calculated by dividing the company's market cap by the company's operating cash flow in the most recent fiscal year (or the most recent four fiscal quarters); or, equivalently, divide the per-share stock price by the per-share operating cash flow. In theory, the lower a stock's price/cash flow ratio is, the better value that stock is.

Initial Public Offering

Initial Public Offering (IPO), also referred to simply as a "public offering", is when a company issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.

In an IPO, the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value.

Stock Option

Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security, or in a futures contract. In other words, the holder does not have to exercise this right, unlike a forward or future.

For example, buying a call option provides the right to buy a specified quantity of a security at a set strike price at some time on or before expiration, while buying a put option provides the right to sell. Upon the option holder's choice to exercise the option, the party who sold, or wrote, the option must fulfill the terms of the contract.[1][2]

The theoretical value of an option can be determined by a variety of techniques. These models, which are developed by quantitative analysts, can also predict how the value of the option will change in the face of changing conditions. Hence, the risks associated with trading and owning options can be understood and managed with some degree of precision compared to some other investments.

Exchange-traded options form an important class of options which have standardized contract features and trade on public exchanges, facilitating trading among independent parties. Over-the-counter options are traded between private parties, often well-capitalized institutions, that have negotiated separate trading and clearing arrangements with each other. Another important class of options, particularly in the U.S., are employee stock options, which are awarded by a company to their employees as a form of incentive compensation.

Other types of options exist in many financial contracts, for example real estate options are often used to assemble large parcels of land, and prepayment options are usually included in mortgage loans. However, many of the valuation and risk management principles apply across all financial options.

American Stock Exchange

The American Stock Exchange (AMEX) is an American stock exchange situated in New York. AMEX is a mutual organization, owned by its members. Until 1929 it was known as the New York Curb Exchange.[4] On 2008-01-17, NYSE Euronext announced it would acquire the American Stock Exchange for $260 million in stock.[5]

Stock Derivatives

A stock derivative is any financial instrument which has a value that is dependent on the price of the underlying stock. Futures and options are the main types of derivatives on stocks. The underlying security may be a stock index or an individual firm's stock, e.g. single-stock futures.

Stock futures are contracts where the buyer is long, i.e., takes on the obligation to buy on the contract maturity date, and the seller is short, i.e., takes on the obligation to sell. Stock index futures are generally not delivered in the usual manner, but by cash settlement.

A stock option is a class of option. Specifically, a call option is the right (not obligation) to buy stock in the future at a fixed price and a put option is the right (not obligation) to sell stock in the future at a fixed price. Thus, the value of a stock option changes in reaction to the underlying stock of which it is a derivative. The most popular method of valuing stock options is the Black Scholes model.[3] Apart from call options granted to employees, most stock options are transferable.

Secondary Market

The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering.[1] Alternatively, secondary market can refer to the market for any kind of used goods. The market that exists in a new security just after the new issue, is often referred to as the aftermarket. Once a newly issued stock is listed on a stock exchange, investors and speculators can easily trade on the exchange, as market makers provide bids and offers in the new stock.

Stock Share

Suppose a group of persons or a business organization propose to start a new project requiring large amount of money which they are unable to arrange. They form a public limited company and invite the public to be a part of the project. The company as per laws of the government announces the issue of shares through which any eligible person can become a shareholder of the company. The word stock simply refers to a supply. You may have a stock of T-shirts in your closet or a stock of pencils in your desk. In the financial market, stock refers to a supply of money that a company has raised. This supply comes from people who have given the company money in the hope that the company will make their money grow. A market is a public place where things are bought and sold. The term "stock market" refers to the business of buying and selling stock. The stock market is not a specific place, though some people use the term "Wall Street"—the main street in New York City's financial district—to refer to the U.S. stock market in general.

In financial markets, a share is a unit of account for various financial instruments including stocks, mutual funds, limited partnerships, and REIT's. In British English, use of the word shares in the plural to refer to stock is so common that it almost replaces the word stock itself. In American English, the plural stocks is widely used instead of shares, in other words to refer to the stock (or perhaps originally stock certificates) of even a single company. Traditionalist demands that the plural stocks be used only when referring to stock of more than one company are rarely heard nowadays.

The income received from shares is called a dividend, and a person owning shares is called a shareholder.

A share is one of a finite number of equal portions in the capital of a company, entitling the owner to a proportion of distributed, non-reinvested profits known as dividends, and to a portion of the value of the company in case of liquidation. Shares can be voting or non-voting, meaning they either do or do not carry the right to vote on the board of directors and corporate policy. Whether this right exists often affects the value of the share. Voting and non-voting shares are also known as Class A and B shares respectively.

Dividends

Dividends are payments made by a corporation to its shareholder members. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.

For a joint stock company, a dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. For the joint stock company, paying dividends is not an expense; rather, it is the division of an asset among shareholders. Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

Cooperatives, on the other hand, allocate dividends according to members' activity, so their dividends are often considered to be a pre-tax expense.

Dividends are usually settled on a cash basis, as a payment from the company to the shareholder. They can take other forms, such as store credits (common among retail consumers' cooperatives) and shares in the company (either newly-created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

It also appears that unrealistically high future growth rates (often as much as 5 years out, reduced to an annual rate) are sometimes used. The key is that management's expectations of future growth rates can be set arbitrarily high; this is a self-serving ploy where the objectives are to keep themselves in office and to make the stock artificially attractive to investors. A prospective investor would probably be wise to check out the reasonableness of the future growth rate by checking to see exactly how much the most recent quarter's earnings have grown, as a percentage, over the same quarter one year ago. Dividing this number into the future P/E ratio can give a decidedly different and perhaps a more realistic PEG ratio.

Dow Jones Utility Average

The Dow Jones Utility Average (also known as the "Dow Jones Utilities") is a stock index that keeps track of the performance of 15 prominent utility companies.

Tender Offer

Tender offer is a corporate finance term denoting a type of takeover bid. The tender offer is a public, open offer (usually announced in a newspaper advertisement) by an acquirer to all stockholders of a publicly traded corporation to tender their stock for sale at a specified price during a specified time, subject to the tendering of a minimum and maximum number of shares. Tender offers are made directly to shareholders and are commonly used to takeover a target company when that company's board of directors does not approve the acquisition. In the United States, tender offers are regulated by the Williams Act.

To induce the shareholders of the target company to sell, the acquirer's offer price usually includes a premium over the current market price of the target company's shares. For example, if a target corporation's stock were trading at a value of $1/share, an acquirer might offer $1.15/share to its shareholders on the condition that 51% of shareholders agree. Cash or other securities may be offered to the target company's shareholders as consideration, although a tender offer in which securities are offered as consideration is generally referred to as an "exchange offer."

Leverage Buyout

A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or "bootstrap" transaction) occurs when a financial sponsor acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (borrowing) which the company being purchased is obligated to repay.

Companies of all sizes and industries have been the target of leveraged buyout transactions, although because of the importance of debt and the ability of the acquired firm to make regular loan payments after the completion of a leveraged buyout, some features of potential target firms make for more attractive leverage buyout candidates, including:

Low existing debt loads;
A multi-year history of stable and recurring cash flows;
Hard assets (property, plant and equipment, inventory, receivables) that may be used as collateral for lower cost secured debt;
The potential for new management to make operational or other improvements to the firm to boost cash flows;
Market conditions and perceptions that depress the valuation or stock price.

Call Options

A call option is a financial contract between two parties, the buyer and the seller of this type of option. Often it is simply labeled a "call". The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.

The buyer of a call option wants the price of the underlying instrument to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples).

Call options are most profitable for the buyer when the underlying instrument is moving up, making the price of the underlying instrument closer to the strike price. When the price of the underlying instrument surpasses the strike price, the option is said to be "in the money".

The initial transaction in this context (buying/selling a call option) is not the supplying of a physical or financial asset (the underlying instrument). Rather it is the granting of the right to buy the underlying asset, in exchange for a fee - the option price or premium.

Exact specifications may differ depending on option style. A European call option allows the holder to exercise the option (i.e., to buy) only on the option expiration date. An American call option allows exercise at any time during the life of the option.

Call options can be purchased on many financial instruments other than stock in a corporation. Options can be purchased on futures on interest rates, for example (see interest rate cap), and on commodities like gold or crude oil. A tradeable call option should not be confused with either Incentive stock options or with a warrant. An incentive stock option, the option to buy stock in a particular company, is a right granted by a corporation to a particular person (typically executives) to purchase treasury stock. When an incentive stock option is exercised, new shares are issued. Incentive stock options are not traded on the open market. In contrast, when a call option is exercised, the underlying asset is transferred from one owner to another.

Naked Short Selling

Naked short selling, or naked shorting, is the practice of selling a stock short without first borrowing the shares or ensuring that the shares can be borrowed. Naked shorting is not necessarily a violation of the federal securities laws, and can contribute to market liquidity, but is illegal when it drives down stock prices.[1] In 2004, the Securities and Exchange Commission (SEC) issued "Regulation SHO" seeking to curb abusive naked shorting.[2] Concern about abusive naked short selling has increased during 2008, and in June the SEC issued a temporary order restricting short-selling of the shares of 19 financial firms deemed systemically important.[3]

Warrant

In finance, a warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue.

Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. They can be used to enhance the yield of the bond, and make them more attractive to potential buyers. Warrants can also be used in private equity deals. For instance, it was a common practice during the height of the dot-com bubble for a landlord of sought-after commercial real-estate to demand warrants from high-tech startups as part of the lease agreement. Frequently, these warrants are detachable, and can be sold independently of the bond or stock.

Corporations issue warrants to enhance the future value of their stock to the people holding it.

Strike Price

In options, the strike price, or exercise price, is a key variable in a derivatives contract between two parties. Where the contract requires delivery of the underlying instrument, the trade will be at the strike price, regardless of the spot price (market price) of the underlying instrument at that time.

Definition - The fixed price at which the owner of an option can purchase, in the case of a call, or sell, in the case of a put, the underlying security or commodity.

Mutual Fund

A mutual fund is a professionally managed firm of collective investments that collects money from many investors and puts it in stocks, bonds, short-term money market instruments, and/or other securities.[1] The fund manager, also known as portfolio manager, invests and trades the fund's underlying securities, realizing capital gains or losses and passing any proceeds to the individual investors. Currently, the worldwide value of all mutual funds totals more than $26 trillion. [2]

Since 1940, there have been three basic types of investment companies in the United States: open-end funds, also known in the US as mutual funds; unit investment trusts (UITs); and closed-end funds. Similar funds also operate in Canada. However, in the rest of the world, mutual fund is used as a generic term for various types of collective investment vehicles, such as unit trusts, open-ended investment companies (OEICs), unitized insurance funds, and undertakings for collective investments in transferable securities (UCITS).

Hedge Fund

A hedge fund is a private, largely unregulated pool of capital whose managers can buy or sell any assets, make speculative trades on falling as well as rising assets, and participate substantially in profits from money invested. It charges both a performance fee and a management fee. Typically open only to very wealthy qualified investors, hedge fund activity in the public securities markets has grown substantially, accounting for approximately 10% of all U.S. fixed-income security transactions, 35% of U.S. activity in derivatives with investment-grade ratings, 55% of the trading volume for emerging-market bonds, and 30% of equity trades.[citation needed] Hedge funds dominate certain specialty markets such as trading within derivatives with high-yield ratings and distressed debt.[1]

Sociologist, author, and financial journalist Alfred W. Jones is credited with the creation of the first hedge fund in 1949.[2]

In the United States, an investment fund must be restricted to a limited number of accredited investor[3]s in order to be exempt from direct regulation.[citation needed] While there is no legal definition for "hedge fund" under U.S. securities laws and regulations, typically they include any investment fund that, because of an exemption from certain regulation that otherwise apply to mutual funds, brokerage firms or investment advisors, can invest in more complex and risky investments than a public fund might. Because they are not open to the public, they do not have to make public disclosures of their investments or investors. Hedge funds managed from other countries have similar relationships with their national regulators. Since a hedge fund's investment activities are limited only by the contracts governing the particular fund, it can make greater use of complex investment strategies such as short selling, entering into futures, swaps and other derivative contracts and leverage.

As the name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging their investments using a variety of methods, most notably short selling. However, the term "hedge fund" has come in modern parlance to be applied to many funds that do not actually hedge their investments, and in particular to funds using short selling and other "hedging" methods to increase risk, and therefore return, rather than reduce it.[citation needed]

Hedge funds have acquired a reputation for secrecy due to the protection of proprietary investment strategies. While many believe that hedge funds are outside the regulatory regime that is applied to retail funds, there still remains significant disclosure that is required to be made when specific triggers are met, but in general informational disclosure is less burdensome than that of registered funds. Additionally, divulging trading methods and positions would compromise the business interests of many types of hedge fund, tending to limit the information they want to release.[4]

The assets under management of a hedge fund can run into many billions of dollars, and this will usually be multiplied by leverage. Their sway over markets, whether they succeed or fail, is therefore potentially substantial and there is a continuing debate over whether they should be more thoroughly regulated.

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