Glossary of Terms

Basis Point (BPS). A basis point equals a fraction of 1%, so 1bps= .01%, and 100bps = 1%.

Bond spread. Represents additional yield on a bond relative to a benchmark, which is typically U.S. Treasuries. For example, if a corporate bond has a spread of 100bps (i.e. 1%), then the yield on that corporate bond is 100bps higher than that of U.S. Treasury. So, in this example, a Corporate Bond with a yield of 2% would have a spread of 100bps above a U.S. Treasury with a yield of 1%. Bond spreads are also a useful way to compare companies within a sector. For example, if the spread on a 10-year Apple bond was 70bps and the spread on a 10-year Microsoft bond was 50bps, the Apple bond is cheap relative to the Microsoft bond.

Bond yield. The yield on a bond represents the return an owner of a bond will realize over the life of the bond. For example, if the yield on a 10-year US Treasury is 0.7%, then 0.7% is the expected annual return on that bond over its lifetime.

  • Yield to maturity (YTM): The total annual return expected on a bond if held until maturity will all payments made and reinvested at the YTM.
  • Yield to worst (YTW): A measure of the lowest possible yield that can be received on a bond based on the earliest call or retirement date. For bonds without options YTW is generally the same as the YTM.

Capitalization Rate (cap rate). A valuation metric used to help evaluate real estate properties for investment. The Cap rate on a property equals Net Operating Income (NOI)/Purchase Price. Net Operating Income is the Gross Rental Income on a property minus operating expenses such as vacancies, property taxes, property insurance, maintenance, utilities, and other expenses.

Consumer Price Index (CPI). CPI is a measure of inflation based on the weighted average price of a basket of consumer goods and services. The index is created by the U.S. Bureau of Labor Statistics (BLS) and is reported monthly, with data going back to 1913. CPI is calculated by taking price changes for each item in the predetermined basket of goods and services and averaging them. The major categories include: Housing, Apparel, Transportation, Education and Communication, Food and Beverages, Medical Care, Recreation and Other Goods and Services.

Permanent Life Insurance. Permanent Life Insurance refers to a life insurance policy which never expires, unlike term life insurance. Permanent life insurance policies combine a death benefit with a savings component. The two major types of permanent life insurance are whole life and universal life. Whole life insurance policies involve fixed premiums for the life of the insured and combine a death benefit with a savings component. The savings component is called the cash value, and interest may accumulate on a tax-deferred basis, which can then be withdrawn by the insured. Universal life insurance provides greater flexibility than whole life insurance as policyholders can adjust both their premiums and death benefits. Additionally, universal life policies only accumulate cash value to the extent that premiums exceed the cost of the insurance.

Personal Consumption Expenditure (PCE) Index. The PCE is another inflation index and is created by the Bureau of Economic Analysis (BEA). The PCE has the same consumption categories as the CPI but assigns different weights to the consumption categories than the CPI Index. There are several other differences between the indices including the fact that the PCE measures spending by both households and nonprofit institutions while the CPI just measures spending by households. Additionally, the PCE is a chained index which uses expenditure data from the current period and the proceeding period, while the CPI uses a fixed base. This allows for better incorporation of households substituting newly developed products and services. The Federal Reserve uses the PCE as their preferred measure of inflation, and the PCE index tends to run 0.3-0.5% lower than the CPI index.

P/E multiples. Price/Earnings multiples represents a company’s price divided by its earnings as measured over the past year (trailing P/E), or expected earnings over the next year (forward P/E). These multiples are a helpful way to compare companies within a sector as well as comparing the overall stock market. In terms of company analysis if Apple’s stock trades at a 10x trailing P/E multiple and Microsoft’s stock trades at a 15x trailing P/E multiple, Apple is cheap relative to Microsoft. Investors will also look at P/E multiples for an index such as the S&P 500 to compare how the S&P 500 is valued relative to other indices and to its historical P/E multiples.

Real Estate Investment Trust (REIT). A REIT is a company that owns, operates, or finances real estate. To qualify as a REIT, a company must invest at least 75% of its total assets in real estate and derive at least 75% of its revenue from real estate. Additionally, REIT’s must pay out at least 90% of their taxable income to shareholders to maintain their REIT status. By qualifying as a REIT, the company avoids paying income tax at the corporate level, which allows the company to pay out more in dividends than it would otherwise.

Return on Equity (ROE). Return on equity is calculated as Net Income/Average Total Equity and is a useful metric measuring a company’s profitability relative to its equity capital, ultimately showing how efficiently the company uses capital to generate profits. ROE is another useful metric in comparing individual companies, all things equal, a company with a higher ROE would be a stronger company than one with a lower ROE.

Term Life Insurance. Term life insurance is a life insurance policy that lasts for a specific time period, typically between 10 and 30 years. The insurance company will pay a death benefit to your beneficiary if you die during that term period. Once the term period ends, the policy is no longer in force.

Treasury Inflation-Protected Securities (TIPS). TIPS provide protection against inflation. The principal of a TIPS bond increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.

TIPS break-evens. Represents the rate of inflation at which an investor is indifferent between owning a U.S. Treasury or TIPS (Inflation protected security). The break-even rate is the market’s expectation of future inflation over a number of years.


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