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CFA Investment Foundations Study Review
1. Investment companies: Companies that exist solely to hold investments on behalf of their
shareholders, partners, or unitholders, including mutual funds, hedge funds, venture capital funds, and investment trusts.
2. Futures contract: An agreement that obligates the seller, at a specified future date, to deliver
the buyer a specified underlying in exchange for the specified futures price.
3. Accrued liabilities: Liabilities related to expenses that have been incurred but not yet paid
as of the end of an accounting period.
4. Marginal cost: The cost of producing an additional unit of a product or service.
5. Brokerage services: Trading services provided to clients who want to buy and sell securities;
they include not only executions services (that is, processing orders on behalf of clients) but also investment advice and research.
6. Tracking error: The standard deviation of the differences between the deviation over time of
the returns on a portfolio and the returns on its benchmark; a synonym of active risk.
7. Cash flow rights: The rights of shareholders to distributions, such as dividends, made by the
company.
8. Risk management: An iterative process that helps organizations reduce the chances and
effects of adverse events while embracing the realization of opportu- nities.
9. Cartel: A special case of oligopoly in which a group of producers jointly control the
production and pricing of products or services produced by the group.
10. Capitalism: An economic system that promotes private ownership as the means of
production and markers as the means of allocating scarce resources.
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11. Multiplier effect: An initial increase (decrease) in spending produces an in- crease
(decrease) in GDP and consumption greater than the initial change in spending.
12. Registers: Documents containing obligations, past actions, and future or out- standing
requirements.
13. Floating-rate bonds: A bond with a finite life that offers a coupon rate that changes over
time. Also known as variable-rate bonds.
14. Reinvestment risk: Risk that in a period of falling interest rates, the periodic coupon
payments received during the life of a bond and/or the principal payment received from a lower bond that is called early must be reinvested at a lower interest rate than the bond's original coupon rate.
15. Inferior products: Products whose consumption decreases as income decreas- es.
16. Interest rate risk: The risk associated with decreases in bond prices resulting from increases
in interest rates.
17. Income effect: A change in demand for a product or service as a result of a change in
purchasing power.
18. Zero-coupon bonds: Bonds that do not offer periodic interest payments during the life of the
bond. The only cash flow offered by a zero-coupon bond is a single payment equal to the bond's par value to be paid on the bond's maturity date.
19. Proprietary traders: Traders who trade directly with their clients rather than by arranging
traders with others on behalf of their clients.
20. Bid exchange rate: The exchange rate at which a bank or currency dealer will buy foreign
currency.
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32. Monetary policy: Actions taken by a nation's central bank to affect aggregate output and
prices through the money supply or credit.
33. Hidden orders: Orders that are only seen by the brokers or trading venues that receive them
and cannot be seen by other traders until the orders can be filled.
34. Consumer price index: Constructed by determining the weight (or relative importance) of
each product and service in a typical household's spending in a particular base year and then measuring the overall price of that basket of goods from year to year.
35. Payout policies: Guiding principles that specify how much money an institution, such as a
foundation or an endowment fund, can take from long-term funds to use for the current spending.
36. Fiscal policy: The use of taxes and government spending to affect the level of aggregate
expenditures.
37. Law of diminishing marginal utility: The economic principle that the additional satisfaction
consumers get from each additional unit of a product decreases as the total amount consumed increases.
38. Real GDP: The value of products and services produced, measured at base-year
prices; nominal GDP adjusted for changes in price levels.
39. Initial margin: The amount that must be deposited on the day the transaction is opened.
40. Keynesians: Economists who believe that fiscal policy can have powerful effects on
aggregate demand, output, and employment when there is substantial spare capacity in an economy.
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41. Information ratio: A reward-to-risk ratio defined as the portfolio's mean active return (the
difference between the portfolio and its benchmark) over its active risk (tracking error).
42. Tax-advantaged accounts: Accounts that allow investors to avoid paying taxes on investment
income and capital gains as they earn them. In exchange for these privileges, investors must accept stringent restrictions on when the money can be withdrawn from the account and sometimes on how the money can be used.
43. Stock dividend: A transaction in which a company distributes additional shares of its
common stock to shareholders instead of cash. This transaction increases the number of shares outstanding but not affect the company's value because the stock price decreases accordingly.
44. Demand curve: The curve that shows the quantity of a product or service demanded at
different prices.
45. Productivity gains: Increases in the ratio of gross domestic product (GDP) to units of labor
expended to produce that GDP; increases in output per unit of labor.
46. Liquidity risk: The risk that a financial instrument cannot be purchased or sold in a timely
manner without a significant concession in price.
47. Warrant: An equity-like security that entitles the holder to buy a pre-specified amount of
common stock of the issuing company at a pre-specified stock price prior to a pre-specified expiration date.
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58. Securitization: Creation of new financial products by buying and repackaging securities or
other assets; the creation and issuance of new debt securities that are backed by a pool of other debt securities.
59. Law of demand: The economic principle that as the price of a product increases, buyers
will buy less of it, and as its price decreases, they will buy more of it.
60. Financial account: A component of the balance of payments that reflects in- vestments
domestic entities make in foreign entities and investments foreign entities make in domestic entities. It includes direct investments, portfolio investments, other investments, and the reserve account.
61. Middle office: Core activities of a firm, such as risk management, information technology,
corporate finance, portfolio management, and research.
62. Primary dealers: Dealers with which central banks trade when conducting monetary
policy.
63. Best efforts offerings: Type of public offering in which the investment bank acts only as a
broker and does not take the risk of having to buy securities.
64. Histogram: A diagram with bars that are proportional to the frequency of occur- rence in
each group of observations.
65. Prime brokerage: Bundle of services that brokers provide some of their clients, including
typical brokerage services and financing of their clients' positions.
66. Shelf registration: Sale of new issues of seasoned securities directly to the public little by
little over a long period of time rather than in a single transaction.
67. Yield curve: Term structure of interest rates presented in graphical form
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68. Time-weighted rate of return: A measure of investment performance in which the overall
measurement period is divided into sub-periods. The timing of each individual cash flow is identified and then defines the beginning of the sub-period in which it occurs.
69. Confirmation: Clearing activity that takes place before settlement in which the buyer and
seller must confirm that they traded and the exact terms of their trade.
70. Basic earning power: A measure that compares the profit generated from operations
with the assets used to generate that income.
71. Growth equity: Private equity investment strategy that usually focuses on fi- nancing
companies with proven business models, good customer bases, and pos- itive cash flows and profits but that need additional capital to support their growth plans.
72. General partner: In a partnership, the partner that sets the partnership, raises capital, finds
suitable investments, and make decisions. Unlike limited partners, the general partner has unlimited personal liability for all the debts of the partnership.
73. Floating exchange rate systems: An exchange rate system driven by supply and demand for
each currency, allowing exchange rates to adjust to correct imbal- ances, such as current account deficits.
74. Discretionary relationships: Relationships that permit the service provider to act on behalf of
the client.
75. Arithmetic mean: The sum of items in a data set divided by the number of items.
76. Credit spread: The difference between a risky bond's yield and the yield on a government
bond with the same maturity.
77. Non-discretionary relationship: Relationship that permits the service provider to undertake
only specific tasks that are authorized on a per task basis.
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89. Coincident indicators: Measures of economic activity that are intended to measure the
current state of the economy rather than the past or to predict the future. Coincident indicators have a tendency to change at the same time as the economy measured as a whole.
90. Indirect investments: Purchase of securities of companies, trusts, and part- nerships that
make direct investments, such as shares in mutual funds and ex- change-traded funds, limited partnership interests in hedge funds, asset-backed securities, and interests in pension funds, foundation funds, and endowment funds.
91. Stop order: Order for which a trader has specified a stop price, a price that triggers the
conversion of a stop order into a market order. The stop order may not be filled until a trade occurs at or above the stop price for a buy order and at or below the stop price for a sell order.
92. Spinoff: A form of restructuring in which a company creates a new entity and distributes
the shares of this new entity to existing shareholders in the form of a non-cash dividend. Shareholders end up owning stock in two different companies.
93. Commingled account: Pooling together the capital of two or more investors, which is then
jointly managed.
94. Index of leading economic indicators: A composite of economic indicators used to predict
future economic conditions.
95. Puttable bond: A bond that provides bondholders with the right to sell (or put back) their
bonds to the issuer prior to the maturity date at a pre-specified price.
96. Carried interest: A form of incentive fee that general partners deduct before distributing the
profit made on investments to the limited partners. It is designed to ensure that general partners' interests are aligned with the limited partners' interests.
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97. Forward rate: The exchange rate for forward market transactions.
98. Transaction costs: Costs associated with trading, which include explicit costs (mainly
brokerage commissions) and implicit costs (bid-ask spreads, price impact, and opportunity costs).
99. Hurdle rate: Minimum annual rate of return that the fund must generate before the
investment manager can receive a performance fee.
100. Principals-based: Regulatory system in which regulators set up broad princi- ples within
which an industry is expected to operate.
101. Capitalized: Classifying a cost as generating long-term economic benefits and reporting
it as an asset rather than charging it as an expense to current operations.
102. Managed floating exchange rate system: A floating exchange rate system in which the
central bank intervenes to stabilize its country's currency, usually to maintain the value of the country's currency within a certain range.
103. Management fees: Fees limited partners must pay general to compensate them for
managing investments. Management fees are typically set as a percentage of the amount the limited partners have committed rather than the amount that has been invested.
104. Private equity partnership: Partnership that specializes in private equity in- vestments.
It usually includes two types of partners: the general partner, which is typically a private equity firm, and limited partners, who are investors contributing capital to the partnership.
105. Continuous data: Data that can take on an infinite number of values between whole
numbers.
106. Depositories: Typically, banks and brokerage firms that are regulated and act not only
as custodians but also as monitors, playing an important role in preventing investment fraud.
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117. Economic profit: Equal to accounting profit minus the implicit opportunity costs not
included in total accounting costs; the difference between total revenue and total cost.
118. Operational risk: The risk of losses from inadequate or failed people, systems, and
internal policies and procedures, as well as from external events that are beyond the control of the organization but that affects its operations.
119. Monopolistic competition: A market in which there are many buyers and sell- er who are
able to differentiate their products to buyers and in which each company may have a limited monopoly because of the differentiation of their products.
120. Equity multiplier ratio: A measure of financial leverage that indicates the amount of
total assets supported by one monetary unit of equity.
121. J curve: The graphical representation of net cash flow (that is, the cash distri- butions
net of carried interest minus the sum of the capital calls and management fees) for limited partners. It shows that net cash flows are negative in the early years of a fund, but turn positive toward the end of a fund's life.
122. Geometric average: The average compounded return for each period; the average
return for each period assuming that returns are compounding.
123. Yield to maturity: The discount rate that equates the present value of a bond's
promised cash flows to its market price.
124. Secondaries: Private equity investment strategy that involves buying or selling existing
private equity investments.
125. Balance of payments: Record that tracks transactions between residents of one
country and residents of the rest of the world over a period of time, usually a year.
126. Accounting profit: Difference between the revenue generated from selling products
and services and the explicit costs of producing them.
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127. Accrual basis: Accounting method in which revenues and related expenses are
recorded when the revenues are earned and the expenses are recognized rather than when the cash is received and paid.
128. Industrial production: A measure of economic output by the following three segments
of an economy: manufacturing, mining, and utilities.
129. Current account: A component of the balance of payments that indicates how much a
country consumes and invests (outflows) with how much it receives (inflows). It includes three components, the goods and services account, the income account, and the current transfers account.
130. Elasticity: In economics, how the quantity demanded or supplied changes in response
to small changes in a related factor, such as price, income, and the price of a substitute or complementary product.
131. Financial intermediaries: Organizations that act as middlemen between those who
have money and those who need money.
132. Clearing: All activities that occur from the arrangement of the trade to its
settlement.
133. Investment policy statement (IPS): A written planning document describing a client's
investment objectives-return requirements and risk tolerance-over a relevant time horizon, along with constraints that apply to the client's portfolio. The IPS serves as a guide to what is required and acceptable in the investment portfolio.
134. Cross-price elasticity: The percentage change in quantity demanded of a product or
service in response to a percentage change in the price of another product.
135. Law of diminishing returns: The economic principle that the gain in output from adding
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145. Comparative advantage: A country's ability to produce a good or service relatively
more efficiently (that is, at a lower relative cost) than other countries.
146. Oligopoly: A market dominated by a small number of large companies be- cause
the barriers to entry are high.
147. Discrete data: Data that show observations only as distinct values.
148. Adverse selection: Tendency of people who are most at risk to buy insurance, causing
insured losses to be greater than average losses.
149. Treynor ratio: A reward-to-risk ratio defined as the excess portfolio return (portfolio
return minus risk-free return) over the beta of portfolio returns.
150. Covenants: Actions that the issuer must perform (positive covenants) or is prohibited
from performing (negative covenants).
151. Absolute advantage: When a country is more efficient in producing a good or service
than other countries - that is, it needs less resources to produce the good or service.
152. Security lenders: Investors who have love positions and lend their securities to short
sellers.
153. Depository receipt: A security issued by a financial institution that represents an
economic interest in a foreign company. The financial institution holds the foreign company's shares in custody and issues depository receipts against the shares held. These depository receipts trade like common stock on the local stock exchange.
154. Distribution: The set of values that a variable can take, showing their observed or
theoretical frequency of occurrence.
155. Spot market: Foreign exchange market in which currencies are traded now and
delivered immediately.
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156. Coupon rate: The interest rate for a bond. The bond's coupon rate multiplied by its par
value equals the annual interest owed to the bondholders.
157. Margins: Cash or securities that are pledged as collateral.
158. Dealers: Trading services providers who participate in their clients' trades and stand
ready to buy or sell when their clients want to sell or buy, providing liquidity and profiting when they can buy securities for less than they sell them. Also called market makers.
159. Wrap account: Accounts that give retail investors access to services of
fee-based investment professionals and wrap charges for investment services, such as brokerage, investment advice, financial planning, and investment accounting, into a single flat fee.
160. Clearing houses: Trading services providers that arrange for final settlement of trades.
161. Open market operations: Activities that involve the purchase and sale of
government bonds by a central bank.
162. Current yield: The annual coupon payment divided by the current market price.
163. Current account balance: The sum of the goods and services, income, and current
transfers accounts.
164. Disclosure-based: Regulatory system in which regulators emphasize disclo- sure of
material information.
165. Absolute returns: The returns achieved over a certain time period. Absolute returns do
not consider the risk of the investment or the returns achieved by similar investments.
166. Churning: Excessive trading to increase commissions.
