GLOSSARY

Financial Market

A financial market is a mechanism that allows people to trade in financial securities, commodities and other items of value at prices that reflect efficient market hypothesis (prices reflect all known information). In finance, the financial markets facilitate in raising capital (capital market), transferring risk (derivatives market) and international trade (currency market).

 Types Of Financial Markets

Capital Market - where listed company shares and long-term bonds are traded e.g. Karachi Stock Exchange.

Commodity Market - where trading of commodities like gold, oil and agricultural products are conducted e.g. National Commodity Exchange.

Money Market - where short-term debt instruments are traded and investments conducted e.g. inter-bank market.

Derivatives Market - where instruments to manage financial risk are traded e.g. National Commodity Exchange.

Foreign Exchange Market - where trading of foreign currencies takes place.

Primary Market

It is a market where securities are offered to the public for the first time hence the Initial Public Offering (IPO) is also sometimes called the primary issue.

Secondary Market

The buyer of the initial/primary issue can sell the securities to another party and this is done in the secondary market where issued securities are traded amongst secondary investors.

Preferred Stock And Ordinary Shares

Preferred stock holders have a higher claim over assets and earnings of the company than ordinary of common stock holders. In the event of liquidation, for example, payments are made to the preference share holders before payment is made to the ordinary share holders. Although details of preference shares are specific to each company, they generally carry a fixed dividend amount, usually callable at the option of the company and generally having no voting rights.

Right Share

One of the ways in which a company can raise capital by issuing right shares to the existing shareholders in proportion to their current holdings. In a right issue, the shareholders have a right to buy the specified number of shares at a specified price and within specified time. The right issue may be rejected or accepted by the shareholder. Usually right issues are transferable allowing the shareholder to sell ‘rights’ in the market.

Market Capitalization

It is the measure of the economic size of a company and is the product of outstanding shares of the company and its price on a particular day and hence reflects on public’s opinion on the value of the company. For a stock exchange, market capitalization is the value of the market capitalization of all shares traded on the exchange.

Free Float

Free float of a company is the number of shares held by investors and which are readily available in the market i.e. excluding those held by promoters and government and strategic holdings.

Green Shoe Option

A Green Shoe Option is an option which in the event of oversubscription of an issue allows the issuer to sell additional shares than originally planned.

Underwriting

It is a process by which an underwriter (intermediary between the issuer of a security and the public, usually an investment bank) offers a new issue to the public. The underwriter guarantees a certain price for a certain number of securities to the issuer in return for an underwriting commission. The issuer is, therefore, assured that a minimum amount would be raised from the expected issue.

Central Depository System

An electronic book entry system (CDS) to record and maintain securities and to register their transfer. In CDS, ownership of securities is transferred without physical movement of securities. It is, therefore, a settlement vehicle.

Mutual Fund

A mutual fund is a financial intermediary that allows a group of investors to pool in their money for a predetermined objective. Mutual funds vary based on investment objectives e.g. equity fund, bond fund or balanced fund. A mutual fund is managed by a fund manger who is responsible for investing in different securities/bonds based on the investment objective of the fund. When an individual invests in a mutual fund, he basically buys units/shares or portions in the fund and becomes a unit-holder.

Net Asset Value (NAV)

The Net Asset Value (NAV) of a fund is its price per unit. It is calculated on a daily basis by dividing the total value of all the securities in the portfolio (total assets) less liabilities by the number of units outstanding.

Advantage Of Investing In Mutual Fund

A mutual fund gives small investors access to a well diversified portfolio of equities, bonds and other securities. Diversification is important as it helps to mitigate risk i.e. if one investment is down, another could be up. Moreover, it takes less time and cost for a small investor to buy a mutual fund with a diversified portfolio than if one were to buy individual scrips and built ones own portfolio. The fund invests and manages investor’s money according to the objective stated in the prospectus.

Difference Between An Open-End And A Closed-End Fund

An open-end fund's units can be bought and sold without any limit on the number of units the fund can issue. The fund continues to sell units as it takes in money from investors and redeems them when investors wish to sell. The price of the open-end fund is determined by its NAV (Net Asset Value). Open-end fund's NAV is calculated at the end of each day using the closing prices of all the securities in the portfolio. The National Investment Trust (NIT) is an example of an open-end mutual fund.

A closed-end fund issues a fixed number of units. Capital is raised during the offering period and once the period is closed, investors can buy and sell the fund on a stock exchange. The price of the fund is determined by its demand and supply and trades like a common stock. Closed-end funds usually trade at a discount to their NAV.

Asset Management Company (AMC)

An investment management firm that invests the pool of funds received from clients in securities according to the defined investment objective. It charges a fee for diversification, liquidity and professional management, consulting and advice.

Front-End And Back-End Load

Front-end load or sales charge is a fee charged when a mutual fund is bought and hence reduces the amount of your investment. Back-end load is a fee charged when the mutual fund is sold and usually depends on the length of time the investor has invested in the fund i.e. contingent load.

Management Fee

Management Fee is the fee paid to the manager of the fund out of the fund’s assets.

Types Of Funds

Mutual funds are classified according to their investment objective and hence according to the composition of their portfolio. The risk of the fund would, therefore, differ according to the nature of the securities comprising the asset portfolio of the fund.

Fixed Income Funds

Invests in fixed investment securities like certificate of deposits and bonds. They are generally less risky than other types of funds except money market (cash) funds.

Money Market (Cash) Funds

Invests in money market instruments only. They invest in short-term debt obligations of less than one year namely treasury bills, certificate of deposits, commercial paper, etc. They are generally less risky than other types of funds and are highly liquid due to the short-term and liquid nature of the securities held.

Stock/Equity Funds

Consist of investments in listed shares. They are generally more risky than other types of funds. The equity funds differ according to their objectives and sectors they invest in.

Balanced Funds

These funds invest their assets in both stocks and bonds in defined proportions. They are, therefore, less risky than pure stock funds and can change portfolios based on the outlook for the market.

Asset Allocation Funds

Invests in a variety of securities in different asset classes. Some funds have a specific breakdown of assets while others vary the composition of the portfolio according to opportunities arising in the market.

Capital Protected Funds

Guarantees the protection of the initial investment made by the investor provided the investment is held till maturity. Hence the key feature is capital preservation and to ensure this, the funds generally invest a greater percentage in debt/fixed return based instruments while the remaining is invested in equities or any other instrument.

Islamic Funds

Islamic funds invest in Shariah complaint securities and instruments. These funds may be equity, income, money market or any other fund depending upon their investment objective (the only difference being that the securities forming the portfolio are Shariah complaint).

Fund Of Funds

Are funds that invest in other mutual funds. Sometimes called multi-management funds, they allow investors a broad diversification by investing in different mutual funds wrapped up into one fund.

Standard Deviation

Standard Deviation measures the price movement/volatility of a fund. The higher the standard deviation, the bigger the price swing and hence the more volatile the fund.

Sharpe Ratio

A Sharpe Ratio is a risk-adjusted performance measure of return per unit of risk. Comparison of Sharpe Ratios of different funds show which fund offers the most favoured risk/return tradeoff. The higher the Sharpe Ratio, the better is its risk-adjusted performance.

Treynor Ratio

The Treynor Ratio measures return in respect of return per unit of systematic risk. In other words, it measures returns earned in excess of that which could have been earned on a riskless investment per unit of market risk. Its similar to the Sharpe Ratio except it uses Beta as the measure of volatility.

Information Ratio

Information Ratio measures returns of a portfolio above the returns of a benchmark to the volatility of those ratios. It also identifies consistency of the manager. The higher the IR, the more consistent the manager is in beating the benchmark.

Beta

Beta is the measurement of volatility of a security or portfolio when compared to a market or index as a whole i.e. it is the movement of the fund when compared to an index. Beta is calculated using regression analysis. A beta of 1 means that the price would move with the index, more than 1 would mean price would be more volatile than the index and beta of less than 1 would mean the price is less volatile than the index.

Gross Domestic Product

Gross Domestic Product (GDP) of a country is the total value of the final goods and services produced in a country. Its therefore the monetary value of total consumption, gross investment, government purchases and net exports during a specified period.

Balance Of Trade

Balance of Trade is the difference between the value of goods exported and imported by a country. Trade surplus occurs when exports exceed imports and trade deficit occurs when imports exceed exports.

Balance Of Payment

Balance of payment measures monetary inflows and outflows in a country. It has two components i.e. balance of payment on current account and balance of payment on capital account. Balance of payment on current account includes balance of trade and import and export of services whereas capital movement between countries is included in the balance of payment on capital account.

Fiscal & Monetary Policy

Fiscal Policy is  the government’s taxation and spending policy with the objective of raising national output, income and employment. Monetary Policy is the monitoring and regulation of money supply and interest rates by the Central Bank.

Consumer Price Index (CPI)

Consumer Price Index (CPI) is an Index which reflects on the inflation in the economy. It measures changes in the price level of a basket of commodities and services. In Pakistan, the CPI is a weighted average rate of a basket of 374 items calculated on a monthly basis.