The Zimbabwe Stock Exchange (ZSE) has provided this information as an educational service to investors. The information provided is not a legal interpretation of regulator policy. Investors who have questions about the meaning or application of any of the Information provided should consult with a certified and licensed stock broker, investment advisor or financial advisor.
Accrued interest is the interest that is due on a bond since its last interest payment was made. A typical bond pays interest every six months, on dates based on its maturity date. A bond holder who sells a bond between interest payment dates is entitled to the accrued interest the bond earned during the time the bond holder owned the bond. The bond buyer pays the seller the market price plus accrued interest. Accrued interest is calculated from the last coupon date up to, but not including the settlement date.
Active Fund Management
Active Fund Management refers to a portfolio management strategy where the fund manager makes specific investments with the goal of outperforming an investment benchmark index. The fund manager purposely shifts funds between different asset classes and securities and uses various strategies to construct portfolios and not just replicate the benchmark index. The effectiveness and success of an actively managed fund depends on the skill and expertise of the portfolio manager.
Active Securities are securities, which are most frequently traded at the stock exchange both in terms of volumes traded as well as in terms turnover.
Acquisition refers to all business and corporate organization (ownership and management) brought under the control of a new management. It usually involves the process of acquiring shares with voting rights of another company with a view to obtaining or consolidating the control of that company.
An agent is normally a representative of a stockbroker and is involved in the business of buying and selling securities for a return commission through the principal, the stockbroker.
Algorithmic trading is most widely used by large institutional investors such as hedge funds, mutual funds and pension funds. Algorithmic trading system uses advanced mathematical models called algorithms, for making decisions and transactions in the financial markets. A computer, programmed with an algorithm, will enter electronic trading orders when certain technical conditions are met. These conditions can include timing, price, the quantity of the order, and general market trends, among other factors.
All or None (“AON”)
AON is a restriction placed on an order to execute the entire size of the order at a time without splitting it into several lots.
Allotment Letter is a document issued by a company to investors showing the number of shares (securities) allotted to the applicant subscribing for such securities. It also indicates the number and the value of shares.
Amalgamation is when two firms, previously independent, coalesce to form a new business.
Amortization is the gradual diminution and liquidation of a liability, such as a mortgage, loan, etc. by regular payments over a specified period of time. In other words, it is the allocation of a lump-sum amount to different time periods. Also, it is the depreciation of intangible assets or investment over the projected life of the asset.
An angel investor is a private investor who provides capital for entrepreneurial start-ups or expansion. An angel investor acts alone or as part of a syndicate. An angel investor participates in the equity of the company by buying stocks or convertible debt instruments. The holding period is usually less than ten years. Compared to a venture capitalist, an angel investor takes bigger risks and expects to make larger profits by investing in start-ups. Unlike a venture capitalist, an angel investor often has business experience relevant to the industry sector, adds value to the new venture, and takes an active role in managing the company. An angel investor tries to minimize risks by restricting investments to familiar industries closer home.
An arbitrager benefits from market imbalances. S/He would locate an asset in a lower-priced market and then immediately resell in another market at a higher price, in order to profit from the price differential. Often, an arbitrager is a seasoned investor who has a deep understanding of the markets. From an economic standpoint, an arbitrager can help reduce market price disparities and increase a market’s liquidity.
Arbitration is a means to settle a disagreement though an impartial agent, the arbitrator. In order to properly carry out arbitration, an arbitrator is chosen by the two parties involved in the dispute. The key purpose of arbitration is to resolve the dispute by determining an equitable settlement.
Articles of Association
Articles of Association are documents describing the purpose, place of business, and details of a company.
An asset-backed security (ABS) is a bond created by a pool of financial assets such as credit card payments, trade receivables and a variety of homogenous loans. The utility of an asset-backed security is that it enables holders of illiquid assets to convert them into marketable securities. An asset-backed security is synthesized in a process called securitization, wherein the pool of investments is sold off to an investment vehicle, which, in turn, issues the asset-backed security representing those obligations in the form of a bond. It enables the issuer to transfer any risk inherent to the underlying pool of funds to investors who buy such security.
Asset Management Company
An Asset Management Company (“AMC”) is a financial services company that chooses the investment opportunities for its clients. The asset management services provided by such a company might feature a mix of traditional investments, such as stocks and bonds, and alternative investment vehicles, which are not available to average investors.
Assets Under Management
Assets Under Management (“AUMs”) indicate the size of a fund or a group of funds. It is the market value of a portfolio of assets owned by investors. It is a measure of the size of the business. Changes in AUMs may indicate both inflows and outflows of the fund- clients investing in and withdrawing from the fund or gains and losses in the value of assets the fund holds.
An at-the-money option is an option whose strike price is equal to the market price of its underlying security. Suppose, if a call option on a stock has a strike price of $0.50 and the stock is currently trading for $0.50 per share, the call option is trading at the money. However, the buyer of an at-the-money option would not exercise the option as long as it remains an at-the-money option because it has no intrinsic value. Option premium consists of intrinsic value and time value. The time value of an at-the-money option is influenced chiefly by the amount of time remaining until the expiration date.
An auction is a method of asset sale by competitive bidding. An auction is most useful when the potential price of the asset to be sold is uncertain. When a seller is not in a position to deliver the securities he has sold, the buyer sends in his application for buying-in, so that the securities can be bought from the market and delivered to him. This process by which the securities are procured on behalf of the defaulter is known as auction.
Automated Trading System (“ATS”)
This refers to a computerized system of trading where trades are executed online. Stockbrokers enter their trades both buy and sell orders at their offices without their physical presence at the stock exchange during trading time and the trades are matched online. The ZSE migrated to ATS on 6 July 2015.
When the prices in the spot market are higher than a particular futures contract, it is said to be trading at backwardation. It indicates immediate shortage of goods, a situation wherein the steady flow of goods is affected and may drive the markets into backwardation. As a strategy, an individual in the short position would benefit the most by delivering as late as possible.
A balance sheet, also referred to as a Statement of Financial Position, is a snapshot of the financial position of an entity as on a certain date. It represents the assets and liabilities of the entity on the particular date. Owner’s equity (networth) is equal to assets minus liabilities. The assets are listed in the order they can be converted to cash; the liabilities, in the order they must be liquidated. Thus, a balance sheet acts as an indicator of the company’s health, such as the liquidity position, leverage, financial soundness, etc.
Basis is calculated as cash price minus the futures price. A positive number indicates a futures discount (backwardation) and a negative number, a futures premium (Contango). Unless otherwise specified, the price of the nearby futures contract month is generally used to calculate the basis.
Basis risk is the uncertainty associated with the convergence of the futures and spot prices, which results from the market risk mismatch between a position in the spot asset and the corresponding futures contract. If the instrument to be hedged and the underlying used are imperfect substitutes, the basis risk is higher.
Bear is a market speculator who believes that the market prices will fall hence does sell their securities in anticipation of buying them back at lower prices in the future.
In a bear market, the prices of assets illustrate a declining trend and the market experience slower volume activity and displays lack of confidence. It is a transition from high investor optimism to widespread investor fear and pessimism. Conversely, when prices are increasing it is termed as bull market. The terms ‘bear’ and ‘bull’ are derived from the way in which each animal attacks its opponents; i.e., a bull will thrust its horns up into the air, while a bear will swipe it down. These actions are related metaphorically to the movement of a market: if the trend is up, it is considered a bull market; if the trend is down, it is a bear market.
Beneficial Ownership/Interest refers to the entitlement to receive some or all of the rights deriving from ownership of a security or financial instrument (e.g. income, voting rights and power to transfer). Beneficial ownership is usually distinguished from legal ownership of a security or financial instrument.
Beta is used by investors to assess the volatility of any stock, mutual or hedge fund, or portfolio relative to its market. It is a measure of the systemic risk of a security or portfolio. Systemic risk is the risk that is common to the whole economy, which cannot be diversified. It is also known as market risk and is denoted by β. Beta gives an indication of the performance of particular securities or portfolios against market return. For market return, benchmark index returns such as the ZSE All Share Index are considered. If securities beta is 1, it means the price of the security will move in the same direction as the index. If securities beta is more than 1, say 1.3, it means stock price is 30 percent more volatile than the index return.
Bid is a buy side of the quoted share, which is the highest price a buyer is willing to pay to purchase a security.
The bid- ask spread is the difference between the price sellers are asking for and the price that buyers are willing to pay. Bid is the available price at which an investor can sell shares and ask is the available price at which an investor can buy shares. Bid and ask together create the dealer’s quotation. This system of bid and ask pricing is used by the stock markets to match buyers and sellers. The ask price is almost always a little higher than the bid price. The difference, or spread, between bid and ask is what the market makers use as their profit margin for handling the transaction.
Bonds are long-term fixed interest securities issued by government and corporate bodies. In effect, they are promissory notes in which the issuer makes an obligation to pay interest at specified times and intervals and to pay back the principal at maturity of the Bond. The holders of bonds get interest even if the issuer does not make a profit.
These are additional shares given to existing shareholders at a specified ratio and paid for from the company’s normal revenue reserves. Bonus shares are mostly issued in lieu of paying cash dividends although a company can issue both.
Shares issued free of charge to shareholders is called a bonus issue. These shares are issued in a certain proportion to the existing holdings, i.e., a 2 for 1 bonus indicates that for every one share of the company held by the shareholder, he is entitled to two additional shares. Bonus shares are issued out of the free reserves of the company, which is accumulated by retaining part of its profit over the years. The main advantage of a bonus issue is that the stock becomes more liquid as there will be many more shares to buy and sell. Bonus shares dilute the market price of the shares in direct proportion to the increase in the total number of shares on issue.
Book Building Process
Corporates may raise capital in the primary market by way of an Initial Public Offering (“IPO”), rights issue, or private placement. An IPO can be made through the fixed price method, book building method or a combination of both. Book Building is essentially a process used to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The issue price is determined after the bid closure based on the demand generated in the process.
A book runner is a lead merchant banker who is appointed by the issuer company for maintaining and managing the book-built issue of the company. It keeps a record of all the bids from investors and helps the company determine the final issue price. While a company going public needs to have a minimum of one book-running lead manager, there can be more than one book-runner for an issue as well. The name of the book-running lead manager will be mentioned in the offer document of the issuer company.
Book value indicates what each share of a company is worth according to the books of accounts. It is the value of an asset on a balance sheet. Also, book value means the net asset value of a company, which is calculated by adding all the assets of a firm and subtracting intangible assets and liabilities. From an investor’s point of view, one compares a company’s book value to its market capitalization to determine whether its stock is undervalued or not.
Broker is an entity engaged in the business of buying and selling securities for and on behalf of investors at a commission.
Bubble is an economic cycle characterized by rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate.
A market speculator who believes that the market prices will rise hence buys securities in anticipation to sell at a profit in the future.
In a bull market, the prices of instruments are generally trending higher and the sentiment is that prices will continue to accelerate. The bull market tends to be associated with rising investor confidence and expectations of further capital gains. In a bull market, market indices and volume of trade are on the rise as also the number of fresh companies entering the market.
A buyback occurs when a company repurchases its own shares from the marketplace. Companies may decide on a stock buyback if they feel their shares are undervalued. A stock buyback can also occur when companies have surplus cash on their balance sheets. Stock buybacks may be executed in the open market at prevailing prices. If the stock buyback intends to acquire a large percentage of the available shares, it may be done as a tender offer with shareholders receiving a premium over the market price. By repurchasing all outstanding shares, a stock buyback can be used to turn a public company into a private one.
The right in options contracts to buy underlying securities at a specified price at a specified time. Call also refers to provisions in bond contracts that allow issuers to buy back bonds prior to their stated maturity.
Call Money Market
Call money market refers to the market for short-term funds with maturity period ranging between one and 14 days. When money is borrowed or lent for a single day, it is called call money, and when money is borrowed or lent for more than one day and up to 14 days, it is known as notice money. In the call money market, only banks and primary dealers are allowed to borrow and lend money.
A call option is an option contract that gives the owner (also called the buyer or holder) the right to buy (or ‘call’) a fixed amount of an underlying security at a stated price within a specified period of time. The owner of a call option has the right to call the security from the option writer (seller) at a fixed price called the exercise price or strike price. The writer of the call option is obligated to sell the security at a fixed price to the option holder if the holder of the call option chooses to exercise the call.
Capital Adequacy Ratio
Capital Adequacy Ratio (“CAR”) is a ratio that regulators in the banking system use to watch banks’ health, specifically a bank’s capital to its risk. It determines the capacity of a bank in terms of meeting the liabilities and managing other risks such as credit risk, market risk, and operational risk. It is a measure of how much capital is used to support the bank’s risk assets. The bank’s capital is the ‘cushion’ for potential losses, protecting the bank’s depositors or other lenders. Regulators in the banking system track a bank’s CAR to ensure that it can absorb a reasonable amount of loss.
Capital asset is a tangible property that is owned and is likely to remain in the possession of the owner for an extended period of time. This is permanent in nature and is utilized as part of a revenue generating process, such as the operation of a business. Land, building, machinery, and equipment are classic examples of capital assets. The benefits acquired from these assets last for longer duration (more than one year) and extend up to 15-20 years in the case of certain assets
Capital Asset Pricing Model
Capital Asset Pricing Model (“CAPM”) derives a relationship between expected risk and expected return. In essence, the CAPM is built on the investment theory that higher risk justifies higher returns. The CAPM states that the return on an asset or security is equal to a risk, free return, plus a risk premium. Thus, according to the model, the projected return must be on par with or above the required return to rationalize the investment. It is a fairly complicated device used primarily by financial practitioners to calculate the pricing of high-risk securities.
Capital gain is a profit that results from investments in a capital asset such as stocks, bonds, or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor. Capital gains may refer to ‘investment income’ that arises in relation to real assets, such as property; financial assets, such as shares/stocks or bonds; and intangible assets, such as goodwill.
Capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price. It is the loss incurred when a capital asset (investment or real estate) decreases in value. This loss is not realized until the asset is sold for a price that is lower than the original purchase price.
Capital markets foster the mobilization of savings into productive investments by providing an outlet for accumulated capital (savings) and allocating the capital to investments that bring the greatest value to the economy.
Carry trade is a popular trading strategy used in the Forex markets. When a currency with a low interest rate is sold to purchase a currency that pays a high interest rate, it is called carry trade. The difference in the interest rates of the two currencies is called the interest rate differential and it is the interest rate differential that is the profit a trader makes. The objectives of carry trade involve making money on the interest rate differential and gaining profit from the capital appreciation. If the carry trade pair appreciates in value, it is better return on the initial investment. The biggest risk in a carry trade strategy is the absolute uncertainty of the exchange rates.
Cash Reserve Ratio
The Cash Reserve Ratio (“CRR”) refers to the liquid cash that banks are required to maintain with the central bank as a certain percentage of their demand and time liabilities. These reserves are designed to satisfy withdrawal demands and would normally be in the form of fiat currency stored in a bank vault (vault cash) or with a central bank. The reserve ratio is sometimes used as a tool in monetary policy, influencing the country’s economy, borrowing, and interest rates. It is expressed as percentage and varies from time to time. It is mandated by the central bank of the country. It is an effective tool to monitor credit expansion by restricting the amount of money supplied in the economy.
A central counterparty is an entity that interposes itself between the market participants. It minimizes the counterparty risk the participants are exposed to. The seller of the security sells to the central counterparty, which simultaneously sells to the buyer. It acts as the buyer to every seller and the seller to every buyer. This means that if any of the party defaults, the central counterparty will bear the losses.
Central Securities Depository (“CSD”)
A central securities depository holds securities on behalf of investors either in certificated (physical) or uncertificated (electronic also referred to as dematerialized) form to enable book entry transfer of securities. To reduce market wide operational risks in the capital markets of Zimbabwe, Chengetedzai Depository Company was formed in 2010 to undertake the setting up and operation of an electronic CSD.
Certificate of Deposit (“CD”)
A certificate of deposit is a short-term fixed-deposit investment option offered by banks and lending institutions. It offers higher interest rates than conventional savings accounts because it requires investors to deposit funds for a specified term up to one year. CDs are issued at a discount to face value.
Circuit breaker is used by a stock exchange to restrict trading of a particular stock or an index. If an index falls or rises by a certain percentage, the exchange triggers trading halts or restrictions on trading. There are two types of circuits, i.e. upper circuit when the index shows a strong upward movement and lower circuit when the index falls considerably.
Circular Trading is a fraudulent activity in the stock market in which two brokers or market players trade a stock back and forth to give the impression of huge trading volume. It is a method whereby a buyer and a seller of shares/stocks come to an understanding; both sell order and buy order will be matched with the price as well as the quantity, creating large volumes in the trading of specific scrips. It pushes the share price upwards and the brokers take undue advantage from the rise in share prices. It is illegal as it does not allow competition and does not result in a change of beneficial ownership.
A clearing house provides clearing services for trades that take place on an exchange. It also provides a range of services related to the clearance and settlement of trades and the management of risks associated with the resulting contracts. It is generally a central counterparty to all trades, i.e., the buyer to every seller and the seller to every buyer and is responsible with the transfer of ownership.
Collective Investment Schemes
A collective investment scheme is run by an entity that allows investors to pool their money and invest in the pooled funds, rather than buying securities directly as individuals. Generally, these are managed by a fund management company that is paid a fee for doing so. The fee is usually a percentage of the amount of funds under management, and it may also be linked to performance. Other costs that investors in various collective investment schemes may face are entry or exit charges, spreads, broker’s commission, and stamp duty. Mutual funds and hedge funds are the most common collective investment schemes.
A commercial paper is a short-term unsecured negotiable instrument issued by highly rated companies.
The fee charged by a broker/investment bank for services performed in buying or selling securities on behalf of a customer/investor.
Contago is a situation where the futures contract prices are higher than the spot price. The holder of a futures contract will benefit from any gains in the price of the underlying. The gain can be realised either by selling the commodity after taking delivery on expiry of the futures contract, or by selling the futures contract. In a well-integrated market, Contago is equal to the cost of carry, i.e. interest rate on investment, loss on account of loss of weight etc.
Contrarian investment strategy follows going against the views of the market, i.e. investments made are generally considered to run counter to the usual pattern of investing. For example, contrarian investors are likely to sell shares that are currently favoured and buy shares that are out of favour. They are also likely to prefer sectors, markets, or types of investments that other investors avoid and sell. The basic premise of this strategy is to get a good investment idea before others notice it.
Convenience yield is the amount of benefit associated with physically owning a particular asset, rather than owning a futures contract for that asset. It is the degree of benefit or premium that is derived from directly owning that particular asset. Convenience yield does not address the benefits of holding a derivative contract on the asset. Convenience yield is based on actual possession and not on owning a futures contract or some other arrangement. It holds its significance when there is a shortage of certain commodities.
The difference between spot and futures prices theoretically should have a declining trend over the life of a contract and tend to become zero on the date on maturity. In other words, the futures and spot prices should be the same at the time of maturity of the contract. This is known as convergence of the spot and futures prices.
Convexity is the change in duration of a bond per unit change in the price of the bond. Calculation of change in price for change in yield, which is based on duration, works only for small changes in prices. This is because the relationship between bond price and yield is not strictly linear; i.e., the unit change in price of the bond is not proportionate to the unit change in yield. Over large variations in prices, the relationship is curvilinear; i.e., the change in bond price is either less than or more than the change in yield, proportionately. This is measured by a concept called convexity.
When a company announces a corporate action, it brings actual change to its securities either in terms of number of shares in the market or a change to the face value of the security. It is important for an investor to understand the different types of corporate actions and their effects so as to have a clearer picture about a company’s financial affairs and how that action will influence the company’s share price and performance. Corporate actions are agreed upon by a company’s Board of Directors and authorized by the shareholders. Dividends, stock splits, rights issues, and bonus issues are a few examples of corporate actions.
A corporate bond is a debt security issued by a company in order to expand its business. Corporate bonds are generally issued with a maturity of over a year. The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations. Also, the company’s physical assets may be used as collateral for bonds. Corporate bonds are considered higher risk than government bonds. The higher a company’s perceived credit quality, the easier it becomes to issue higher amounts of debt at lower rates.
Cost of Capital
The cost of capital is the required rate of return that a company should achieve in order to cover the cost of generating funds in the marketplace. The required rate of return is dependent on the creditworthiness and riskiness of the company’s business. If the risk is higher, the investors would lend funds; i.e. invest in a company only if they get higher returns. The cost of capital is equal to the return that the investor receives. In other words, it is the benchmark for measuring the profitability of an investment.
Cost of Carry
The cost of carry is generally understood to be the cost that is associated with holding on to a physical commodity for a specified period of time. Cost of carry includes storage, insurance on the physical commodity, and any funding costs incurred in acquiring and maintaining control of the commodity. The cost of carry is the cost of ‘carrying’ or holding a position. If the position is long, the cost of carry is the cost of interest paid. If the position is short, the cost of carry is the opportunity cost, the cost of purchasing a particular security rather than an alternative.
Cost of Equity
The cost of equity is the minimum rate of return that a business or organization must offer investors or owners to offset their wait for a return on investment for a given level of risk. The cost of equity can be calculated for a given industry based on the current rate of return. Cost of equity can also be determined by the CAPM. The cost of equity does not show up on a company’s income statement.
Counterparty risk is the risk borne by each party in any transaction if the counterparty fails to fulfil his/its obligation son account of failure to pay the amount or to deliver securities. Counterparty risk is as crucial for the regulators as it is for the institutions exposed to it, as a systemically important large financial institution will be a counterparty to many others. Therefore the failure of one institution can cause turmoil in the financial markets all across.
The coupon rate is the nominal interest rate paid by the company to its bondholders periodically in order to compensate the bond holder for lending funds to the company.
Credit rating estimates the ability of an individual or a company to pay back a loan. Based upon the credit history and repayment details as well as the availability of assets and extent of liabilities of the applicant, it is determined whether or not a loan should be given to the applicant and the interest rate to be charged. For issuers of debt instruments, it helps the investors determine the likelihood that the bond issuer will pay coupon payments in a timely fashion and the initial investment at maturity.
Cross hedging refers to hedging a trader’s position by taking an offsetting position in another product with similar price movements. Though the two products are not identical, they are correlated to create a hedged position as long as the prices move in the same direction. For cross-hedging to work, it is essential to have a logical connection between the two separate investment opportunities. For example, cross hedging a crude oil futures contract with a short position in natural gas. Though these two products are not identical, their price movements are similar.
C-TRADE is an innovation developed to harness and promote participation of every type of investor from the smallest retail to the largest institutions in financial and capital markets, through mobile and internet based platforms. It comes in as an additional channel for investors to access the Zimbabwean capital market. C-TRADE allows investors to place orders on their own on the Automated Trading System (ATS) platform, used by the Zimbabwe Stock Exchange Limited (“ZSE”), giving them direct access to the market with enhanced efficiency and convenience. The C-TRADE suite offers a number of order routing options which allows equal access to all computer, simple and smartphone mobile users.
This terms means “with dividend”, “with bonus” or “with rights”. The buyer of the security is entitled to a dividend, bonus declared or rightly to subscribe for further shares.
This term means “with dividend”. The buyer of such security is entitled not only to the share but also to a dividend that has been declared but has not been paid yet
Currency appreciation refers to the rise in value of a currency relative to other currencies or gold. Appreciation occurs when a unit of one currency can buy more units of another currency because of a change in exchange rates. Conversely, currency depreciation refers to decrease in the value of a currency with respect to another currency. This means that the depreciated currency is worth fewer units of the other currency. While depreciation means a reduction in value, it can be advantageous as it makes transactions in the depreciated currency less expensive.
A currency pair is a price quote showing how much of one currency is needed to buy one unit of another currency. A currency pair is normally shown as a ration of currency symbols. Most commonly traded currency pairs also called the majors, are EUR/USD, USD/CHF, USD/JPY, GBP/USD. The base currency in any currency pair is the currency the investor will buy or sell. The counter currency in any currency pair is the currency the investor will use to purchase or sell the base currency. In the USD/ZAR currency pair, USD is the base currency and the ZAR is the counter currency.
Current yield is equal to a bond’s annual interest payment divided by its current market price. Current yield does not factor in the price appreciation on a discount bond or the price depreciation on a premium bond that is held to maturity. For a par bond, nominal yield, current yield and yield to maturity are equal.
A custodian is an entity that holds the documentary evidence of the title to property that belongs to an investor, such as share certificates, for safekeeping. In a clearing corporation, a custodian is a clearing member and not a trading member. The custodian settles trades assigned to him by trading members and is required to confirm whether he is going to settle a particular trade or not. If it is confirmed, the clearing corporation assigns that obligation to that custodian and the custodian is required to settle it on the settlement day. If the custodian rejects the trade, the obligation is assigned back to the trading member.
In a book-building issue, the issuer is required to indicate either the price band or a floor price in the Prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called ‘cut-off price’. This is decided by the issuer and lead manager after considering the order book and investors’ appetite for the stock. Only retail individual investors have the option of applying at cut-off price.
A cyclical stock is one whose profits are highly correlated with the business cycle. When the economy is in expansion, a cyclical stock generates increased profits. Conversely, when the economy slows the prospects for a cyclical stock diminish. A cyclical stock may be found in sectors such as automobile, travel, or manufacturing. The common thread is discretionary purchases that may be postponed during difficult economic times. For investors with longer time frames, purchasing a cyclical stock during an economic downturn is a classic contrarian strategy.
Dealing is the act of buying, selling or agreeing to buy or sell or trade shares by either a fund manager or stock dealer.
A debenture is an acknowledgement of debt by a company. Debentures may be secured against certain specific properties of the company. However, debentures may also be unsecured or may be convertible to equity at a future date, to be exchanged for the company’s ordinary shares at the holders’ option depending on the agreement. Interest on debentures is payable on specified dates whether or not there are sufficient profits.
Debt securities are fixed income securities with a fixed rate of return and are guaranteed, no voting rights and no benefits from exceptional performance by a company. They include bonds, debentures, notes, or other similar instruments representing or evidencing indebtedness whether secured or otherwise.
The delta of a derivative is the rate of change in the price of a derivative with respect to price change in the underlying asset. In other words, it is the change in the price of a derivative from a one unit change in the price of the underlying security. The delta is not a fixed value. It depends on the price of the underlying security. The relationship between the two depends on the characteristics of both the derivative and the underlying. Delta is of crucial significance in hedging.
Delisting refers to the process of removing a company from the official list of the stock exchange as a result of inaction or poor performance, failure to fulfil the exchange rules or failure to meet the listing requirements or the financial specifications. Delisting may also be voluntary.
Demat refers to a dematerialized account, where securities are held in electronic format. A Demat account is opened by the investor while registering with an investment broker. The Demat account number is quoted for all transactions to enable electronic settlements of trades to take place.
Dematerialisation Process – Investors that hold physical share certificates need to deposit their shares to the CSD – a process called dematerialisation. Dematerialisation which is done at no cost requires investors to open securities accounts with either the stockbrokers or custodians and deposit their securities.
Demutualization is a process by which a mutual company owned by its users/members converts into a company owned by shareholders. In a mutual exchange, the three functions of ownership, management, and trading are concentrated in a single group. Here, the broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well. Demutualization leads to the segregation of management and the trading rights in an exchange.
A depository is an organization that holds investors’ securities in electronic form and also provides services related to various transactions in such securities. A depository interfaces with its investors through the respective depository participants. Depository participants are usually banks and brokerage houses who have a direct link with the depository. The depository in Zimbabwe is Chengetedzai Depository Company (CDC).
Depository Receipt (“DR”)
A depositary receipt
(DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, which is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity securities of companies in other countries.
A derivative is a security that derives its value from another asset. The asset in which its value depends is called the underlying asset. It is a contract to buy or sell an asset at a future date with a predetermined price. Derivatives are used for both hedging risk and as high risk investments. Varied derivative instruments include futures, options, warrants and swaps.
Diluted share is a term used in reporting earnings per share, as in ‘earnings per diluted share’. Few companies have complex reporting structures with securities that have the potential of becoming common shares. Such companies must report earnings on both ‘basic’ (non-diluted) and diluted share basis. Computing earnings on a diluted share basis involves consideration of options, warrants, contingent shares, and convertible securities. This increases the weighted average of outstanding shares upon which diluted share earnings are computed.
Discounted Cash Flow (“DCF”)
A discounted cash flow is a fundamental technique to value an investment. The value of an asset is the value of the future benefits it brings. The value of an investment is the cash flows that it will generate for the investor: interest payments, dividends, repayments, returns of capital, etc. The DCF approach is based on calculating the present value of the generated stream of cash flows by the company. In a DCF valuation, a discount rate is chosen, which reflects the risk; higher the risk, higher the discount rate, and this is used to discount all forecast future cash flows to calculate a present value.
Diversification means dividing the investment across a variety of assets. Diversification across asset classes is the foundation for long-term successful investment strategies. It can be achieved either by investing in one type of asset classification, such as buying stocks of leading companies across varied sectors, or in different types of asset classes such as stocks, bonds, money market, real estate, currency market, etc. Diversification across asset classes minimizes the volatility in the return achieved, as each asset class has different risks, rewards, and tolerance to economic events. By selecting investments from different asset classes, the risk gets minimized.
A dividend is a payment to shareholders paid out of the Company’s distributable profits. It is paid to everyone who is registered as a shareholder at the record date. There is no guarantee that a company will make dividend payments in any given year or years.
Due Date Rate (“DDR”)/Final Settlement Price (“FSP”)
In a futures contract, the Due Date Rate (“DDR”) or the Final Settlement Price (“FSP”) is the price at which all outstanding positions are settled on the maturity of the contract. DDR/FSP is the last spot price as on the expiry day or the weighted average of spot and/or futures prices of the specified number of day(s), as may be defined in the by-laws, rules, and regulations of the exchange.
Due diligence is an exercise undertaken to ensure the correctness of everything as it appears. In an investment context, it refers to the checks carried out before making a transaction. Due diligence is carried out by a bidder before making a takeover bid, by an underwriter prior to an IPO or any other issue, by a venture capitalist before making an investment. It implies gaining access to a company’s accounts that are not available in the public domain.
Duration of a bond is a measure of the time taken to recover the initial investment in present value terms. In simplest form, duration refers to the payback period of a bond to break even; i.e., the time taken for a bond to repay its own purchase price. Duration is expressed in number of years.
A dynamic hedge is one that needs to be adjusted as the price or other characteristics of the security being hedged undergo changes. The change in the price of an option is perfectly correlated to the change in the value of the underlying asset and hence, dynamic hedge is essential. This means that options can only be hedged by re-balancing them continuously.
Earnings Per Share (“EPS”)
Earnings per Share is a measure of the company’s profitability from an investor’s perspective. It is the portion of a company’s profit allocated to each outstanding share of common stock. It is a major constituent used to calculate the Price to Earnings Ratio and is an important factor of the price of a share.
An efficient market is one in which the securities prices reflect all available information. Depending on the information available, markets are classified as weak form, semi-strong form, and strong form of market efficiency. In the weak form, the securities prices reflect only the past information. In the semi-strong form, prices incorporate all the information available in the public domain. In the strong form, prices reflect all information that any investor can acquire, including insider information.
Equities or shares represent a claim to a company’s assets (everything the company owns including buildings, equipment and trademarks) and earnings (all the money the company makes after meeting all obligations).
The equity market, commonly known as the stock market is the financial system where the shares of a company are issued and traded. The equity market accelerates the capital formation activity. It enables the investors to own a part of the company and benefit from the future gains of the company and provides an opportunity to participate in the company’s success through an increase in its stock price. However, the risk involved in equity markets is higher than debt markets, given the analogy: higher return, higher risk.
Equity Risk Premium
Equity risk premium is the excess return in the stock market that is above the return offered by government securities. Equity risk premium offsets the overall market risk by providing the extra return over a risk-free investment; it compensates the investors for taking higher risk. The equity risk premium helps in ascertaining portfolio returns and in selection of securities. A higher risk premium would imply that the portfolio is skewed towards stocks with higher risk. The primary premise of the equity risk premium comes from the risk-return trade-off.
This terms means “without dividend”, “without bonus” or “without rights”. The buyer of a security, which has been declared as “ex-all”, will not be entitled to dividends when it is paid, bonus shares and rights issues when declared and issued.
Exchange Rate Risk
Exchange rate risk is the risk faced by the investors because of the volatility in exchange rates, which, in turn, may affect their investments. Exchange rate risks can result from buying foreign currency denominated investments, the export or import trade of a corporate, investing in companies that have operations in another country, and so on.
Exchange- Traded Fund (“ETF”)
An exchange-traded fund is an investment fund and its units can be bought and sold on a stock exchange. It will have a smaller bid-offer spread as it is set by the market rather than the fund manager. ETFs are open-ended and are likely to trade at close to their net asset value.
This is the opposite of “cum-dividend”. The purchaser of a security, which has been declared as “ex-div”, will not be entitled to dividends when it is paid. Normally, the price is adjusted to reflect the dividend payment.
The exercise price, or strike price, is the price at which the owner can exercise an option. It is the predetermined rate that is fixed by the two parties at the time of entering into a derivatives contract. A call option entitles the holder to buy the underlying asset at the exercise price, and a put option entitles the owner to sell the underlying at the exercise price. If the market price is significantly above the exercise price, the call option can be exercised at a profit and vice versa for a put option.
Expense ratio is the charge an investor pays on a mutual fund as a fee for actively managing his/her portfolios. This involves the fund management fee, agent commissions, registrar fee, and promoting expenses. All these fall under a single basket called expense ratio or annual recurring expenses. Expense ratio states how much you pay a fund in percentage term every year to manage your money. It indicates the relationship of various expenses to net sales.
The expiration date is the date when a futures or option contract security expires. With a futures contract, either cash settlement or physical delivery occurs on the expiration date. With an options contract, if the option is not exercised by the end of the day on the expiration date, the option expires worthless.
Fair value is a market price that both the buyer and the seller will accept for the goods or services they are transacting. It is the price at which the seller is willing to part with the goods/services and the buyer is willing to part with the money in exchange for that goods/services. It is the price at which supply and demand meet. The fair value implies that the buyer and the seller have all the information relevant to the transaction and are not in any way forced to make the transaction. It may be different from the intrinsic value.
Final Settlement Price (“FSP”)/Due Date Rate (“DDR”)
In a futures contract, the Final Settlement Price (“FSP”) or Due Date Rate (“DDR”) is the price at which all outstanding positions are settled on the maturity of the contract. FSP/DDR/ is the last spot price as on the expiry day or the weighted average of spot and/or futures prices of the specified number of day(s), as may be defined in the by-laws, rules, and regulations of the exchange.
Financial market refers to money markets and capital markets, which constitute the financial system. The money market refers to the short-term aspect of the financial markets, whereas the capital markets refer to the long-term aspects, the cut-off point being the duration of one year.
Free float is the number of outstanding shares of stock available for trading by the public. It excludes the shares that are owned by promoters, company officers, management and various other insiders. Companies with small float are likely to be volatile, since a major trading event may have a substantial impact on the stock price, while companies with bigger float tend to be less volatile.
Fundamental analysis is a method of evaluating a security by attempting to measure its intrinsic value by examining related economic, financial, and other qualitative and quantitative factors. Fundamental analysis focuses on a company’s earnings, revenue growth rates, and valuation ratios. The goal is to produce a value that an investor can compare with the security’s current price and accordingly decide whether to invest in that security.
A Fund manager is a market professional who manages a portfolio of securities for and on behalf of investors. They do this by promulgating research and analysis on the stock market and use this to make investment decisions at a fee. Investors pool together their investments so that they can be managed as collective which then reduces the cost of managing the portfolio of securities.
The futures contract is an agreement to buy or sell an asset at a pre-arranged future time and price. The futures contract is standardized for trade on an exchange; it specifies a quantity of the asset, the delivery month, the last day of trading, and other essential terms.
While options Delta measures how much the value of an option changes with a change in the price of the underlying stock, Options Gamma measures how much the Options Delta changes as the price of the underlying stock changes. Of the five Options Greeks, Delta and Gamma are related to each other, making Options Gamma important to all options traders. Options Gamma measures the magnitude as well as the direction of change, making it crucial for hedging trades.
Green Shoe Option
Green shoe Option refers to an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilizing mechanism in accordance with the specific provisions in disclosure and investor protection guidelines. Green Shoe Option is granted to a company and should be exercised through a stabilizing agent.
Haircut is the difference between the market value of a security and its collateral value. Haircuts are taken by a lender of funds in order to protect themselves – in case a need arises to liquidate the collateral- from losses owing to declines in the market value of the security.
Hedging is a process of limiting investment risk with the use of derivatives such as options and futures contracts. Hedging results in transactions leading to opposite positions in the market in order to ensure a certain amount of gain or loss on a trade is offset by an equal and opposite position. This is employed by portfolio managers to reduce portfolio risk and volatility or lock in profits.
Hybrid Financial Instrument
A hybrid financial instrument is an investment that blends the characteristics of both equity and debt. The most common form of a hybrid instrument is the convertible bond. Such security is an issuance of debt that can be converted to a company’s common stock at any given time. The advantage is that in case the company’s stock price goes down, the option will not be exercised and you will still receive interest payments on your bonds. However, if the stock price goes up, you can convert the bonds to stock at a given strike price.
Immobilization refers to the process whereby physical share certificates are deposited with the central depository.
Implied Volatility is the volatility for the price of an underlying asset based on the price of an option on that underlying. Implied volatility is obtained by solving an option pricing formula such as Black-Scholes for the volatility variable using the current option price. Ordinarily, an option pricing model is used to price an option, using historical volatility. Thus, a difference between implied volatility and historical volatility suggests that market participants believe a security’s performance will be different from past performance.
An Index is statistical composition that measures changes in the economy or the financial markets, normally stated as a percentage from a base year. An index measures the up and down of the prices of such items as consumer goods and services market, shares and bonds market, and commodities market.
An index fund is a portfolio of assets with allocation rules that remain fixed regardless of market conditions, commonly for the purpose of approximating the performance of some market index. The index fund does not have to be linked to an existing index. Typically, an index fund is either a mutual fund or an ETF. An index fund tends to have significantly lower fees and expenses than an actively managed fund because of its passive management style. Taxes are also reduced because less trading lowers realized capital gains for the index fund.
Asymmetry means imbalance. In the context of financial markets, information asymmetry is an imbalance of information among market players where one party has superior information when compared with another party. This causes the former party to have an information advantage over the latter.
Initial Public Offering (“IPO”)
An Initial Public Offering is the sale of shares of a privately owned company to the public for the first time. It is known as trading in the Primary Market. IPOs can be issued by companies seeking to raise capital as well as go public. The issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue, the best offering price, and the time to bring it to market. From an investor’s perspective, it is tough to predict the stock’s performance on debut in the Secondary Market.
Inside information is any kind of data pertinent to the inner workings of a company that has not yet been revealed to the public via financial statements, press releases, or any generally accessible media. Individuals who are purview to inside information are known as insiders. Use of inside information has a vast potential for having serious and detrimental effect on the securities and derivatives of a given company and exploiting inside information for material gain is deemed unlawful.
Institutional investors include organizations such as insurance companies, depository institutions, pension funds, investment companies, and endowment funds, which invest in equity. They have a lot of influence in the management of corporates as they are entitled to exercise the voting rights. As institutional investors have the freedom to buy and sell shares in bulk, they can play a large part in deciding the fate of a company. Influencing the conduct of listed companies and providing them with capital are all part of the job of investment management.
Interest Rate Party
It represents the relationship between the spot rate and the forward rate due to interest rate differentials. If this relationship does not hold true, there would be arbitrage opportunities between the interest rates in two countries.
A financial system exists to serve the primary function of transferring economic resources from the lenders to the borrowers, i.e., from surplus units to deficit units. Financial institutions have evolved to serve the purpose of centralizing the lending and borrowing operations, remodelling economic growth. Institutions such as banks, non-banking financial institutions, etc. serve as mediators to fund transfer. This process of mediating fund transfer from an ultimate source to the ultimate user is termed as intermediation.
The actual value of a security, as opposed to its market value or book value, is the intrinsic value of the security. Intrinsic value may differ from market value because of brand names, patents, and other intangibles that are difficult for investors to quantify. There are various approaches, but there is no standard formula for calculating the intrinsic value of an asset. The concept of intrinsic value is also used in options trading where intrinsic value measures the amount by which the option is in the money.
A person or an institution that uses their savings or borrowings to buy securities.
Investment versus Trading
Trading is the purchase and sale of the security over a short period of time with an intention of profiting. Generally, traders rely on Technical Analysis to make informed decisions and do not conduct comprehensive research. Investing, on the other hand, is likely to be supported by fundamental research, which is the analytical method of predicting long term prospects of a particular asset. Investing involves holding the asset over a longer time frame and benefitting from the long-term appreciation. What separates trading from investing is that generally in trading one has an exit expectation, making the trade to have a finite life. Investing, on the other hand, is more open-ended. An investor buys securities and holds on to their positions as long as they continue to like the prospects and does not think in terms of a price at which to exit the stock.
An investment is an asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.
ISIN (International Securities Identification Number) is a unique identification number allotted for each security.
Issuer refers to a company, corporation, government or body corporate offering (or having already offered) securities for sale to investors or to the public.
Jensen Alpha is an index that compares the performance of investment managers by allowing for portfolio risk. The Jensen index uses the capital asset pricing model (CAPM) as its basis for determining whether or not a money manager outperformed a market index. The CAPM determines the required rate of return, and the Jensen index helps investors see if the calculation yielded expected results. The formula for the Jensen index is as follows: Portfolio Return-[Risk-free Return + (Market Return-Risk-free Return) *Beta Measurement]. A high Jensen index suggests a high level of return, given the level of risk (systemic or market) on the investment. A low Jensen index, such as negative number, indicates inferior performance when compared to the risk.
Large cap is short for large market capitalization, which means publicly traded companies with a market capitalization of $10billion or more as per global standards. This cut-off for large cap companies changes over time and is not authoritatively defined. The purpose of the large cap definition is to separate the large companies from others. A large cap mutual fund invests only in large cap stocks.
Leverage means using small investments to increase the potential return of a much large investment in an asset, thus reducing liability for loss. Leverage is of two types: operating and financial. Operating leverage would be loans or borrowings used to finance a firm’s assets. Financial leverage would take the form of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. Derivative products allow leverage, making them highly risky instruments.
A leveraged buyout (LBO) is the acquisition of a company or a division of a company with a substantial portion of borrowed funds. In a LBO, the assets of the company being acquired are used as collateral for the loans, in addition to the assets of the acquiring company, and going forward the acquired company’s profits are used for the repayment of the loans. The purpose of LBOs is to allow companies to make large acquisitions without having to commit a lot of capital.
Leverage is an investment technique in which you use a small amount of your money to make an investment of much larger value. Leveraged finance is funding a company or business unit with more debt than generally employed in similar companies and industry. More than normal debt implies that the funding is riskier and more costly. Such companies are called as ‘highly leveraged’. Leveraged finance is generally employed for acquisition, repurchasing shares, or investing in a self-sustaining cash-generating asset.
In the context of markets, liquidity is defined as the ease with which an asset can be converted by either selling or buying it without bringing much change in the asset’s price and loss in value. Liquidity for a firm means its ability to honour its obligations and possession of liquid assets.
A trader enters the market when he anticipates a price rise or fall in the stock in which he wishes to invest. A long position indicates buying of a security expecting the price to rise with time, which would enable the trader to book profits on selling the security when the price rises. On the other hand, a short position indicates selling of a security with a view that the stock price would fall with time.
Margin is money borrowed from a broker for trading purposes. Brokers generally require additional disclosures for opening margin accounts, and charge interest when margin is used. Margin is commonly expressed as a percentage. The amount of margin required to hold an existing position is regulated by the exchange where the asset is listed and may differ from the initial margin mandated by the regulator.
A margin call is the demand by a brokerage that an investor contributes additional cash to a margin account. The margin call takes place when securities purchased on margin decline below a certain amount and the account no longer meets the maintenance margin. The investor will generally receive a margin call by phone. In the event a margin call cannot be met, the brokerage will sell securities held in the account until margin requirement is met. Failure to meet a margin call can therefore result in considerable loss. A margin call can often be satisfied with marginable securities in lieu of cash.
In margin trading, an investor can buy shares worth up to four times the available balance in his trading account. The investor has to square off the trades within the same day. If the market moves against the investor’s position, they have to take delivery of the shares and brokerage will be charged as per the agreement with the broker. Margin trading is also referred to as Day trading or Intra-day trading.
Mark to Market
Mark to market is an accounting calculation tracking the current market value of an asset. Mark-to-market calculations are typically done daily. Mark to market is based on the current market value of the assets in question (i.e., commodity, security, derivatives, etc.) Mark to market reflects how much such assets would be sold for if they were put on the market today. Methodologies used in the mark-to-market calculation are classified on two different levels. Level 1: market-prices for the asset are available and can be used in the mark-to-market calculation. Level 2: no market prices are available.
Market capitalization is the value of all outstanding shares. It is calculated by multiplying the number of shares issued and outstanding with the current market price of the share. Market capitalization almost always differs markedly from a company’s net worth because market capitalization is what investors are actually willing to pay for the company. Stocks are often classified by the size of their market capitalization as large-cap stocks, mild-cap stocks, and small-cap stocks.
A market maker brings continuous liquidity to the trading market of a particular stock by standing ready to buy or sell shares any time markets are open at any publicly quoted price. To qualify as a market maker, a brokerage firm is required to buy or sell shares regardless of whether or not it has customer orders. If there are no customer orders, the shares become part of the market maker’s stock inventory.
The market price refers to the ruling price of shares on the trading floor of the exchange at any given time. The market price of share is normally an indicator of the level of demand of that security.
Merchant banking primarily involves financial advisory services for large corporates and wealthy individuals. A merchant bank caters for the commercial banking needs such as international finance, long term company loans and stock underwriting. This type of bank does not have retail offices where a customer can go and open a savings account or current account. A merchant bank is sometimes said to be a wholesale bank, or in the business of wholesale banking. This is because merchant banks tend to deal primarily with other merchant banks and large financial institutions.
Mid-cap (mid-capitalization) means stocks of publicly traded companies with a market capitalization between $2 billion and $10 billion as per global standards. A mid-cap stock offers a middle ground between the growth potential of a small-cap and the reduced volatility of a large-cap. A mid-cap stock tends to offer greater growth potential than a large-cap. It is prone to be more volatile than a large-cap stock but less volatile than a small-cap stock and less vulnerable in economic downturns, compared to a small-cap stock.
When Company A acquires Company B, minority interest represents the equity interest of outside shareholders in consolidated subsidiaries. If the two companies are treated as if they are one for financial statement purposes, an account (minority interest) must be presented to indicate that all the assets and liabilities are not related to Company A. On the balance sheet it appears between liabilities and shareholders’ equity. On the income statement, minority interest is shown as a deduction of consolidated net income.
Money Laundering is a process of converting the proceeds of illegal activities-disclosure of which would trigger financial losses or criminal prosecution-into real or financial assets whose origins remain effectively hidden from law enforcement officials and from society in general.
Money market is the market for short-term financial instruments, which include Treasury bills, bankers’ acceptances, commercial paper, municipal notes, and other securities. Money market instruments have maturities of one year or less. Companies and investors often use money market securities as temporary ‘parking places’ for storing cash. While the returns on money market instruments are relatively low, they are among the safest of investments. They are considered cash equivalents and are included with cash on a company’s balance sheet.
Mortgage- Backed Security (“MBS”)
A Mortgage-Backed Security is a security based upon a pool of underlying mortgage loans. For instance, 500 thirty-year fixed rate mortgage loans of $200 000 each can be combined into a $100 million mortgage-backed security issue. The underlying loans are generally insured against non-payment. Given that each loan in the underlying pool that formed the mortgage-backed security is insured, the primary risk for the mortgage-backed security holder is that of prepayment. The market for mortgage-backed security trading is known as the secondary mortgage market.
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests typically in investment securities such as stocks, bonds, money market instruments, other mutual funds, and/or commodities. It is a financial intermediary that enables a group of investors to pool their money and facilitates accelerated investment activity. When investing in a mutual fund, one is buying units or portions of the mutual fund and the investor becomes a shareholder or unit holder of the fund. The biggest advantage of mutual funds is diversification, by minimizing risk and maximizing returns.
Net Asset Value (“NAV”)
Net Asset Value is the market value of a unit of securities held by a particular scheme. NAV is the total market value of all the securities of a scheme divided by the number of units. As the price of securities is subject to change, NAV of a scheme also changes.
Net worth is the total assets of a company minus its total liabilities. It represents the owners’ interest in company assets, as opposed to liabilities, which represent creditors’ interest. If a firm has little net worth, its assets are mostly financed by debt, and it will have trouble paying its bills in hard times.
As a function, a clearing house acts as a legal counterparty between buyers and sellers; i.e., a clearing house becomes buyer to every seller and vice versa. This prevents the need for ascertaining the credit-worthiness of each participant and the only credit risk that the participants face is the risk of clearing house committing a default. The clearing house puts in place a sound risk management system to discharge its role as counterparty to all participants.
Offer is the opposite of a bid. It is the lowest price at which a stockbroker or dealer is willing to sell a security on behalf of a client or as a principal respectively. Sometimes referred to as the “Ask”.
Offer Document means a Prospectus in case of public issue or Offer for Sale and Letter of Allocation in case of a rights issue, which is filed with the Registrar of Companies (ROC) and stock exchanges. An Offer Document covers all the relevant information to help an investor make his/her investment decision. ‘Draft Offer Document’ means the offer document in the draft stage.
An Offshore Company refers to a corporation, Limited Liability Company (LLC) or similar class of entity formed in a foreign country to that of the principals of the organization or one that can only operate outside of its country of formation. From the standpoint of the principals of the company, it is a company that has been filed outside of the country where its principals (officers, directors, shareholders, members, partners) reside. From within its country of formation, it is a company that has been formed for the purpose of operating outside of the jurisdiction where it was originally filed.
Open Interest is the total number of outstanding contracts that are held by market participants at the end of the day. It is the total number of futures contracts or option contracts that have not yet been squared off, expired or fulfilled by delivery. It is used to confirm trends and trend reversals and measures the flow of money into the market. For each seller of a futures contract there must be a buyer of that contract. Therefore, to determine the total open interest for any given market you need to know only the total from one side.
Open Market Operations
Open market operations are any of the purchases and sales of government securities and commercial paper by a central bank in an effort to regulate the money supply and credit conditions. It can be used to stabilize the prices of government securities. It is the means of implementing monetary policy by which a central bank controls the short-term interest rate and the supply of money in an economy.
Open outcry system refers to a system of trading at the stock exchange floor whereby brokers shout their bids and offers of securities on behalf of their clients.
An option is a contract between a buyer and a writer (seller) of an underlying asset where the buyer retains the right, but not obligation, to buy or sell the underlying asset from/to the writer at a given strike price, either on or before a predetermined expiration date. The buyer of an option pays the writer a premium to offset the risk the writer undertakes. There are two major classes of options: call option and put option.
Option premium refers to the amount that a buyer pays for an option, i.e., the right to buy/call or sell/put a security at a specified price in the future. An option premium is a non-refundable payment for the rights specified in the stock option contract. One pays an option premium regardless of whether or not the option is actually exercised. The option premium often changes due to fluctuating market conditions and economic variables.
Out of the Money
An option is out of the money if it cannot be exercised at a profit, given the current price of the underlying asset. If the option is close to expiration and significantly out of the money, it is said to be deep out of the money. An out-of-the-money option can become not only deep out of the money, but also at the money or in the money, if the price of the asset moves favourably relative to the strike price of the option. A call option is out of the money if the strike price is above the market price of the underlying asset. A put option is out of the money if the strike price is below the market price of the underlying asset.
Over-the-Counter (“OTC”) Derivatives
All derivatives transactions that are carried outside the exchange platform are termed as over-the-counter derivative transactions. These contracts are customized by the parties to the transaction. Some of the OTC instruments are forwards, swaps, swaptions, and exotic options. As these products are customized in nature, they lack liquidity and have high counterparty risk.
A stock is considered to be overvalued if its current price exceeds the intrinsic value. There are many ways to determine if a stock is overvalued. Many investors look at a stock’s Price to Earnings ratio (PE ratio) for determining an overvalued condition. A high PE in relation to its historic PE ratio or a high PE in relation to peer stocks may indicate an overvalued condition. Other measures of an overvalued stock include a comparison of stock price against the company’s cash flow, projected earnings, book value, dividend ratio, etc.
Par Value is the face value or stated value of a security. It is a nominal amount assigned to a security by the issuer. For an equity security, par value is usually a very small amount that bears no relationship to its market price, except for preferred stock, in which case par value is used to calculate dividend payments. For a debt security, par value is the amount repaid to the investor when the bond matures.
When the members bring in their funds/securities to the Clearing Corporation through the depositories, it is called Pay-In. Members with funds obligations make available required funds in the designated accounts with clearing banks by the prescribed pay-in time. The Clearing Corporation sends electronic instructions to the clearing banks to debit members’ accounts to the extent of payment obligations.
After processing for shortages of funds/securities and arranging for movement of funds from surplus banks to deficit banks, the Clearing Corporation sends electronic instructions to the depositories/clearing banks to release pay-out of securities/funds. The depositories and clearing banks debit accounts of the Clearing Corporation and credit accounts of members. Settlement is complete upon release of pay-out of funds and securities to custodians.
Plough-Back of Profits
After deduction of all expenses, the net profits of a company are split into two parts: dividend and plough-back. Ploughed-back of profits is retained as reserves. It is important because it increases the reserves of a company as well as provides the company with funds required for its growth and expansion. Generally, the growing companies maintain a high level of plough-back, whereas companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
A Ponzi scheme is a fraudulent investment scheme that pays high rates of return to the investors. The Ponzi scheme generates returns for current investors by acquiring new investors. This scam actually yields the promised returns to investors as long as there are more new investors. The scam can run for some time because investors appear to be making the promised return. The fact that investors appear to be getting the returns they were promised will encourage more people to put their money in the scheme.
Portfolio is a collection of securities owned by an individual or an institution (such as a mutual fund) that may include stocks, bonds, and money market securities. A portfolio is a collection of investments in different financial assets such as stocks, bonds, and cash equivalents in varied proportions. Portfolio management is the process of managing the financial assets, which involves selecting and monitoring appropriate investments and allocating funds accordingly.
Price Earnings Ratio (“P/E”)
The P/E ratio refers to the number of times it takes a shareholder to recoup his investment in a share. It is given by the market price of a share over its earnings per share. It is the payback period of a share.
The primary market is a part of the capital market that deals with issue of fresh securities on the exchange platform and is also known as new issue market. Companies, governments, and other groups obtain financing through debt or equity-based securities. This market creates long-term instruments through which corporate entities borrow from capital markets. It accelerates the process of capital formation in a country’s economy.
Private placement is funding of securities that are sold without an Initial Public Offering IPO and are sold to a relatively small number of select investors as a way of raising capital. Private placements consist of stocks, warrants, or promissory notes and are generally purchased by institutional investors such as banks, insurance companies, or pension funds. Private placements enable high degree of flexibility in the amount of financing as well as the choice of instrument.
An authorization by a shareholder of a company transferring his/her right to vote to another person through written instructions.
A put option is a bet that the value of its underlying security will fall. A buyer pays a premium to a writer (i.e., seller) for the right, but not obligation, to sell the underlying security to the buyer at any time on or before the expiration date, at a predetermined strike price (for an American-style option). If the value of the underlying security falls below the strike price, the put option is in the money.
A public offer is an offer made by a company to the public to subscribe to new or existing shares being offered for sale to the public as in the privatization exercise.
Random Walk is an economic theory that states prices of securities move randomly. The theory assumes an efficient market. It also assumes that new information comes to the market randomly. Together, the two assumptions imply that market prices move randomly as new information is incorporated into market prices. The theory implies that the best predictor of future prices is the current price, and that past prices are not a reliable indicator of future prices.
Redemption price is the price at which mutual fund shares are redeemed by mutual fund companies. It is calculated from the net asset value of the fund assets divided by the number of fund shares outstanding. It is the price or NAV at which an open-ended scheme purchases or redeems its units from the unit holders. Also, if applicable, it might include exit load.
Registrar to an Issue
Registrar to an issue is the person appointed by a body corporate or any person or group of persons to carry on the activities of collecting applications from investors in respect of an issue; keep a proper record of applications and money received from investors or paid to the seller of the securities; assist in determining the basis of allotment of securities in consultation with the stock exchange; and finalize the list of persons entitled to allotment of securities, refund orders, or certificates and other related documents in respect of the issue.
Reinvestment risk implies the potential risk of investing the future proceeds at a lower rate. It indicates that an investor will not be able to find the same rate of return as the old one on the new investment. The return could be significantly lower, based on what’s happening in the economy at large, though it could also be higher. One way to limit reinvestment risk is by using a technique known as laddering, which means splitting your investment among a number of bonds or CDs that mature gradually over a series of years.
Repo and Reserve Repo
The repo rate is the rate at which the Central Bank lends short-term money to the banks. When the repo rate increases, borrowing from the Central Bank becomes more expensive. Therefore, when the Central Bank wants to make it more expensive for banks to borrow money, it increases the repo rate and vice versa. On the other hand, the reverse repo rate is the rate at which banks park their short-term excess liquidity with the Central Bank. An increase in the reverse repo rate means that the Central Bank will borrow money from banks at a higher rate of interest.
Retained Earnings are accumulated earnings that have not been distributed to shareholders but rather reinvested in the business. A company’s retained earnings are disclosed at or near the bottom of the shareholders equity section of the balance sheet. Accountants may prepare a separate ‘statement of retained earnings’ that shows the change in retained earnings during the accounting period. Retained earnings may be appropriated for specific purposes.
Reverse Stock Split
A reverse stock split is a method used by a company to reduce its number of shares outstanding, while increasing proportionate per-share price. A reverse stock split, the opposite of a stock split, increases the value of each share while the total value of outstanding shares remains the same. Corporates often use a reverse stock split to amplify the price of their stock and attract investors. Many investors do not look favourably upon a reverse stock split as a corporate can use a reverse stock split to hide falling stock prices.
A rights issue entitles existing shareholders to take up additional shares in the company, usually below market price without paying any brokerage. A rights issue enables the company to raise additional funds from shareholders. Shares are offered on a pre-determined pro-rata basis. A rights issue may be renounceable or non-renounceable. Renounceable means shareholders are entitled to sell their rights to other investors and non-renounceable means shareholders must either take up the shares or forfeit the rights.
Risk is the probability of deviation from the expected results. The deviation could lead to either profit or loss. Financial risk mainly arises due to deteriorated performance of economy, price trends, reactions between market participants, and unpredictable events. Investors need to insure or protect themselves from risk by adopting suitable risk management measures. A common practice used by traders to protect them from risk is hedging. A simple measure of risk is standard deviation or variance.
A direct relationship exists between risk and return. 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 trade-off, invested money can render higher profits only if it is subject to the possibility of being lost. A fund manager who maintains a portfolio of stocks, bonds, real estate assets, etc. would evaluate the risks his portfolio is exposed to and would suitably employ measures to mitigate them to maximize returns to achieve the investment goals of the investors.
A rolling settlement takes place within a given number of business days after the date of the trade. This is in contrast to the account period procedures in which the settlement of trades takes place only on a certain day; for example, a certain day of the week or month for all trades that occurred within the account period.
The secondary market is the financial market where previously issued securities and financial instruments such as stocks, bonds, options and futures are traded. In the secondary market, an investor can buy a security directly from another investor instead of an issuing corporation. Majority of the trading is done in the secondary market. The shares are manoeuvred from one investor to another. It has an important role in the development of an efficient capital market. It enables the participants with ample liquidity.
Securities are financial instruments or legal documents signifying either an ownership position in a company (i.e. shares) or a creditor relationship with a company or Government (i.e. stocks and bonds).
Securitization is the process of taking an illiquid asset or group of assets and transforming it/them into a security. Securitization is a method of financing assets wherein, rather than selling the assets as a whole, the assets are combined into a poll, and that pool is split into shares. These shares are sold to investors who share the risk and reward of the performance of these assets. Securitization basically transforms raw assets into tradable units. Some illustrations of securitized products include home mortgages, credit card receivables, auto loans, home loans, student loans, and equipment leases.
Equity markets follow a T+3 settlement cycle, which means that if a trade takes place on Monday, it gets settled on Thursday.
The time prescribed with reference to the date of trade (T) within which brokers are required to deliver the security and pay for the trade through the Zimbabwe Stock Exchange.
A share is a unit of ownership. It is also referred to as equity. When one purchases a share in a company he/she becomes a part owner in that company. He/she will be entitled to certain rights e.g. dividend, voting etc. There are different types and they include the following:
Ordinary shares– shares that give the shareholder part ownership of the company in proportion to the number of shares held and entitle him to dividends. It is the risk capital that is entitled to residual claim assets in the event of liquidation.
Preference shares – shares bearing a fixed annual rate of dividend with a prior right over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment of capital on winding up of the company.
Redeemable preference shares – preference shares that can be redeemed by the company either at fixed dates and prices, or on certain specified terms at the discretion of the board.
Convertible preference shares – preference shares, which may be converted under specified conditions into a specified number of ordinary shares of the issuer.
The Sharpe Ratio is a measure of excess returns generated over and above the risk free rate, per unit of risk. It demonstrates a trade-off between risk and returns. Risk is taken to be the fund’s standard deviation. As standard deviation represents the total risk experienced by a fund, it reflects the returns generated by undertaking all possible risks. A higher Sharpe Ratio is better as it represents a higher return generated per unit of risk. It measures a ratio of return to volatility and is calculated by subtracting the risk-free rate from the return of the portfolio, and then dividing by the standard deviation of the portfolio.
This is a document, which shows ownership of shares. It can be used as collateral in acquiring a loan.
The holder of a short position is bearish on the price of the asset, or expects the price to fall. The opposite of short position is long position. A short position means selling a futures contract in that particular asset. A short position in a stock usually means that the investor has sold borrowed shares with the intention of repaying the borrowed shares later with others purchased at a lower price. Any portfolio position can be described as either a long position or a short position with respect to any asset.
Short selling is selling the shares that you do not own. The broker lends the shares and holds the investment as collateral. In short selling, you have to subsequently square off or close the short by buying back the shares from the market and returning the same to the broker. Interest costs are charged for the loan of shares. If a trader expects that the price of the shares of a company will come down in the future, he is likely to sell the shares at current levels and buy when the price declines, earning a profit.
Small cap represents stocks of companies with a market capitalization between $500 million and $2 billion as per global standards. These are no precise limits as different brokerages, funds, and analysts may define small-cap stock in slightly different ways. Investors may perceive a small-cap stock as having greater growth potential than a large-cap stock. A small-cap stock often has a lower level of institutional interest as many funds have limits on the percentage of a company they may own.
Speculation is the process of selecting investments with higher risk in order to profit from an anticipated price movement. Speculators have a particular view either bullish or bearish, on a particular asset and they profit from fluctuations in the asset prices. The biggest advantage of speculation is that it increases the volume and provides depth to the financial markets. It implies that investors can enter and exit at any moment. However, the disadvantage is that speculation can also cause prices to deviate from their intrinsic value if speculators trade on misinformation.
A special bargain is a trade in shares that is outside the capacity of the market.
Spread is the difference between the bid and the offer prices of a security. It is normally categorized according to the price of the particular securities. It is usually used as a threshold within which trades are concluded.
A sponsoring broker refers to a stockbroker who is appointed by an issuer in a corporate action to liaise between the company and the stock exchange in the process of ensuring that the issue is successful.
A stockbroker is a market professional who buys and sells securities on behalf of clients at a Stock Exchange in return for a brokerage commission. Licensed by SECZ and Member of the ZSE.
A stock buyback occurs when a company repurchases its own shares from the marketplace. Companies may decide on a stock buyback if they feel their shares are undervalued or if they have excess cash on their balance sheets. If the company intends to acquire a large percentage of outstanding shares, it may be done through a tender offer with shareholders receiving a premium over the market price. By repurchasing all outstanding shares, a stock buyback can be used to turn a public company into a private one.
A stock exchange is an organized and licensed market for the buying and selling of listed securities (shares, stocks and bonds). On this market, individuals and companies can buy shares of companies through Licensed Stockbrokers and dealers hence become part-owners lenders to or creditors of the listed companies or the Government.
A stock split occurs when a company releases additional stock in a structured manner without decreasing shareholder equity. For example in a 2 for 1 stock split, an investor who owns 100 shares of a stock valued at USD1 per share before the stock split will own 200 shares valued at USD0.50 per share after the split. After the stock split the investor owns twice as many shares, with each share worth exactly half as much as before the stock split. The purpose of a stock split is to reduce the share price of a stock in order to make the stock more affordable to a wider pool of investors.
The strike price of an option is the price at which the owner of the option is entitled to exercise his option to buy or sell the underlying security or asset. The strike price is also called the exercise price. The strike price determines the intrinsic value of an option. The premium of an option will vary significantly depending on the strike price. A strike price is typically set at regular intervals around the current market price.
Systematic Investment Plan
Systematic Investment Plan (SIP) is a vehicle offered by mutual funds, which indulge the investor to invest regularly. It is similar to recurring deposits. It is a convenient way to accumulate wealth in a disciplined manner by investing in small installments over a long period. A SIP enables investors to participate in the stock market. The sum to be invested is fixed.
Systematic Transfer Plan
Under Systematic Transfer Plan (STP), an amount you opt for is transferred from one mutual fund scheme to another of your choice, at regular intervals. Typically, a minimum of six such transfers are to be agreed on by investors. The mutual fund will reduce the number of units equal to the amount you have specified from the scheme you intend to transfer money. At the same time, the amount transferred will be utilized to buy the units of the scheme you intend to transfer money into, at the applicable NAV. Some fund houses allow transferring only the capital appreciation at regular intervals.
Systematic Withdrawal Plan
Systematic Withdrawal Plan (SWP) enables the investors to automatically redeem a prearranged amount from the mutual fund holdings each month. This is an ideal way to supplement your monthly cash flow, meet minimum withdrawal requirements, or move assets between the funds. It is a no-change service.
Systematic Risk refers to the risk that affects the whole stock market and therefore it cannot be reduced or diversified away. It is due to risk factors that affect the entire market such as investment policy changes, foreign investment policy, change in taxation clauses, shift in socio-economic parameters, global security threats and measures, etc. and is beyond the control of investors and cannot be mitigated to a large extent. As this type of risk is non-diversifiable and unavoidable because no amount of diversification can reduce this risk, the market does compensate for taking exposure to such risks.
T-Bill is a short-term money market instrument issued by the government. T-Bills are issued at a discount to face value. Investors buy the bills at a discount from the stated maturity value (known as face value), and, on maturity, the holder of the T-Bill receives the payments from the government, which is equal to the face value of the bill. T-bills are issued with initial maturities of 91 and 365 days.
Theta is an option Greek variable that measures the rate of decline in the value of an option due to the passage of time. It is also referred to as the time decay on the value of an option. If everything else remains constant, the option will lose value as time moves closer to the expiry of the option. It is generally expressed as a negative number reflecting the amount by which the option’s value will decrease every day. The measure of theta quantifies the risk that time imposes on options as options are only exercisable for a certain period of time. It indicates how much an option’s price will diminish over time.
Time Value of Money
Time value of money is based on the concept that a sum of money that one owns today is worth more than the promise or expectation that one will receive in the future. Money held today is more valuable because one can invest it and earn interest. A key concept of time value of money is that a single sum of money or a series of equal, evenly-spaced payments or receipts promised in the future can be converted to an equivalent value today.
Treynor ratio, also called the Treynor index, is a measure of possible excess returns on investment if more market risk is assumed. The ratio was developed by Jack Treynor. It measures a portfolio’s return earned in excess of what would be earned on a risk-free investment, per unit of market risk or systemic risk. It is the difference of the average return of a portfolio and the average return of a risk-free rate, divided by the beta of the portfolio [(average portfolio return-average return of risk-free rate)/portfolio beta]. It shows how a fund will perform. If the ratio is higher, the performance of the portfolio or stock being analyzed is better.
Based on fundamentals, if a stock is selling at a lower price than what it should be, it is termed as an undervalued stock/. However, the opinion of one analyst might differ from the perception of other analysts. The market may temporarily price stocks too high or too low, and it is possible to find undervalued stocks. Investors use various indicators such as relative valuation to determine whether a stock is undervalued.
An underwriter serves as an intermediary between an issuer of a security and an investor. In this capacity, an underwriter buys an issue of securities from a company and resells it to investors. As an underwriter, a person (or firm) bears the risk of selling the securities to the public and guarantees the proceeds from the sale, essentially taking ownership of the securities. If the underwriter can’t sell the securities at the asking price, he/it may have to sell them for less than he/it paid or retain the securities himself/itself.
The unit holders are the owners of the fund assets. The changes made by the fund house to the attributes of a scheme or decision to wind up the scheme are subject to approval by the unit holders or else the unit holders should be given the option to exit at the prevailing NAV.
Unsystematic risk is the extent of variability in the stock or security’s return on account of factors that are unique to a company. Unsystematic risk is due to factors specific to an industry or a company like labour unions, product category, research and development, pricing, marketing strategy, etc. Unsystematic risk can be mitigated through portfolio diversification, i.e., this type of risk can be diversified away by investing in more than one company because each company is different and therefore this risk is also called diversifiable risk. It is a risk that can be avoided and the market does not compensate for taking such risks. It is also known as asset- specific risk or company-specific risk.
Value investing is an investment technique where one buys shares that are believed to be undervalued in the hope that the true (higher) value of the stock will be realized. Value investing requires more of a long term outlook. Someone who believes the market over-reacts to good and bad news might be more prone to value investing. Investors who opt for value investing look for low price-to-earnings ratios and low price-to-book values. Value investing examines the stock’s current market value and the company’s intrinsic value.
A value stock is a stock that is currently undervalued and has good expectations of price appreciation. In theory, value stock is only temporarily out of favour; when market conditions change and investor interest returns; the value stock will appreciate. A value stock usually pays little in dividends and is likely to be richly valued by conventional valuation methods. It is a safer investment because of its underlying value; however, in a bull market where investor optimism is heady, a value stock may well perform worse than a growth stock.
The Vega of a derivative shows how the value of the derivative changes in respect to a percent change in the volatility of the underlying. When you buy or sell an option, a change in volatility means the option price must be increased/decreased to accommodate new volatility sensitivity. The Vega is at its highest when the underlying is equal to the strike price of the option. As the price of the underlying asset deviates further away from the point where no gain or loss would occur, the Vega drops.
A venture capital firm is an investment company that invests in risky but potentially very profitable new ventures. The venture capital firm may focus on investments in particular industries or technological arenas, or may invest in any attractive opportunity. Each venture capital firm sets its own criteria for accepting investments. If it is open to outside investors, they should be accredited. The individual considering investment in a venture capital firm can perform proper due diligence to guard against fraud.
Volatility is a statistical measure of the tendency of a security’s price to change over time. Volatility is defined as the standard deviation of the return over time T. Volatility must be stated for a specific period of time, such as a day or a year.
Volume Weighted Average Price
It is the average share price of a stock weighted against its trading volume within a particular time frame, generally one day. Volume-weighted average price is calculated as the ratio of the value traded to total volume traded over a particular time horizon. The ZSE uses the volume weighted average price to determine the closing price for each stock after each trading session.
A warrant is a security issued by a company that allows the owner to redeem the warrant for shares of stock in the company at a predetermined price. Like an option, a warrant can be traded on an exchange. Unlike a stock option, a warrant can have a very long duration to expiration, even more than a decade, or no expiration at all. Warrant that never expires is called a perpetual warrant, and a warrant that expires on a specific date is called a subscription warrant. A stock-purchase warrant is an alternative term.
Working capital is a measure to assess a firm’s liquidity position. It is calculated as current assets minus liabilities. Working capital (also known as operating capital) is required for the smooth running of a business. A decrease in working capital translates into less money to settle short-term debt. Working capital can be expressed as a positive or negative number. When a company has more debt than current assets, it has negative working capital. When current assets outweigh debt, a company has positive working capital.
Yield is a return on capital investment of various forms. In the stock market, yield essentially communicates a rate of return made from an investment, such as dividend, which is called dividend yield. Yield is also a function of the bond market, where current yield is a coupon rate of interest divided by the bond’s purchase price, while maturity yield is a rate of return on a bond that takes into account the sum annual interest payment, the purchase price, the redemption value as well as the time period remaining until maturity.
A yield curve is a plot of the yields of all bonds of the same quality, from the lowest to highest maturity. A typical yield curve is based on the yield-maturity relationship of default-free US Treasury securities. There are three basic configurations for yield curve. A positive curve shows that short-term interest rates are lower than long-term interest rates. A flat curve results when short-term and long-term interest rates are about the same. A negative yield curve is seen when short-term interest rates are higher than long-term interest rates.
Yield to Maturity
Yield to maturity measures the total overall return on a bond, if the bond is purchased at today’s market price and held until its maturity date. It comprises of both the yearly interest the investor earns, and the difference between what the investor paid for the bond and the amount the investor receives at the bond’s maturity. It is often referred to as the yield or basis, so a five percent yield to maturity means the same as a five percent yield or five percent basis.
A zero coupon bond is a bond that does not pay interest but instead is sold at a discount, i.e., for less than its face value. For example, a zero-coupon bond with a face value of ZWL$5,000 may sell for only ZWL$4,200. When the zero-coupon bond matures years later, the bond buyer receives the full ZWL$5,000; the ZWL$800 difference is the ‘interest’ earned on the zero-coupon bond. One advantage of issuing a zero-coupon bond is that the issuer does not need to make periodic interest payments to its bond holders. One possible disadvantage to bond investors is that zero-coupon bond prices are more volatile on the secondary bond market since the lack of periodic interest payments is viewed as risky. A zero-coupon bond is also known as an accrual bond.