Guide to Essential Money Tools

Investing Tools

Definitions of money tools

Annual Compound Rate – The annual rate of return earned on an investment which includes any growth.

For example: investment of £100 grows by 5% in the first year. You then have £105 at the start of year 2, this then grows by a further 3%, so at the beginning of year 3 the investment is worth £108.15. This is the effect of compounding.
So a growth of £8.15 on £100 over 2 years is actually an annual compound return of 4% per year, not 8.15% divided by 2.

Basis Point ­– A measurement of fluctuation of an investment, equal to 1/100 of one percent.

Benchmark – An index or other market measurement which is used by a fund manager as a yardstick to assess the risk and performance of a portfolio.

Bid Offer Spread – This is a form of charging whereby the price that units are bought and sold at are different. The price of units which a customer can buy is higher than the price at which they can sell the same units.

Call Option – An option which gives its holder the right but not the obligation to purchase an asset at a predetermined date (maturity date) for a predetermined price (exercise price).

Churning – The practice of acquiring a holding of shares and then placing both buying and selling order for those shares (usually at about the same price or slightly higher) in order to build up turnover.

Compound Interest – In, for example, a deposit account, this is where interest is added to both capital and the accrued interest from time to time. The longer a customer leaves an investment the more advantage they can make of compound interest.

For example: in Year 1 a customer is paid 10% on his/her £100 investment. At the end of Year 1 this investment is worth £110. In Year 2 with compound interest taken into account the customer now earns 10% on £110, giving him/her £121 by the end of Year 2. In Year 3 they earn 10% on £121 giving a grand total of £133.10.

Derivative – A financial contract that derives its value from an underlying security, liability or index. Derivatives come in many varieties, including forwards, futures, options, warrants and swaps. Also known as Synthetic.

Discretionary Trust – This is a type of trust where the trustees can decide who will benefit from the trust and how much they will get.

Earnings Per Share (EPS) – A measure of a company’s performance, calculated by dividing the company’s net operating profit after tax divided by the number of shares in issue.

Fund Yield – A fund yield expresses the amount of income that a fund has paid out in proportion to its price, and is usually stated in annualised terms. It may express either actual or expected distributions. A fund’s yield is commonly associated with a fund’s interest rate or dividend payment.

Hedge Fund – A type of investment portfolio under which the fund manager is authorised to utilise a number of higher risk investment techniques, including using derivatives, short selling and borrowing funds to generate a higher return.

Index – In the stock market, an index is a device that measures changes in the prices of a basket of shares, and represents the changes using a single figure. The purpose is to give investors an easy way to see the general direction of shares in the index. Examples of stock market indices are the FTSE 100, FTSE All-Share, Nikkei and Dow Jones.

Median – The value (rate of return, market sensitivity, etc) that exceeds one-half of the values in the sample and is exceeded by the other half. The median is always the middle value, as distinct from the mean, which represents the average value.

For example: if five items cost £20, £80, £100,
£300 and £500 respectively, the median value would be £100, whereas the mean or average would be £200.

Net Asset Value (NAV) – The valuation of a collective investment based on the market value of securities added to the cash element held in its portfolio. OEICs use this method for valuation purposes.

Nominee – An individual or company in whose name a security is registered to be owned, although the real (or beneficial) ownership is actually held by another party. Nominee companies are often used by share investors who for some reason wish their identities to remain undisclosed or who simply require another party to manage (or hold as custodian) their investments.

Price-Earnings Ratio (PR) – A stock’s market price divided by its current or estimated future earnings per share; a fundamental measure of the attractiveness of a particular security versus all other securities as determined by the investing public. The lower the ratio relative to the average of the stockmarket, the lower the (market’s) profit growth expectations. Also called Earnings Multiple.

Qualifying Policy – A Qualifying policy is a policy which pays out its proceeds free from personal taxation. In order to qualify it needs to adhere to the following qualifying rules. The premiums must be payable for ten years or 75% of the term whichever is the shorter. The premiums must be paid regularly on an annual or more frequent basis such as monthly. The sum assured must be at least 75% of the total premiums payable over the life of the policy. The plan must be certified by HMRC.

Spread – In relation to share, bond and currency markets, the difference between the bid price and the ask (offering) price, incorporating both an estimate of demand and potential profit for the seller. In relation to unit trusts, the difference between the allocation of redemption price of units, as a result of transaction costs incurred in buying and selling the underlying securities which make up the value of the trust. In relation to option markets, the holding of a long position and an offsetting short position, usually in contracts with the same underlying security or asset.

Total Expense Ratio (TER) – The Total Expense Ratio (TER) represents the cost of running a fund. It includes the annual management charge, depository and custodial charges, and audit, registration, and compliance fees.

Volatility – a statistical method that measures how much a series of values move up and down around its average. The higher the volatility number, the less consistent the historical performance has been.

Weighting – The relative proportion of each of a group of securities or asset classes within a single investment portfolio.

Yield Curve – A visual representation of the term structure of interest rates. It shows the relationship between bond yields and maturity lengths. A normal or positive yield curve signifies higher interest rates for long-term investment, while a negative or downward curve indicates higher short-term rates.
Source: Skandia (www.skandia.co.uk)