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Financial Glossary

Beyond mere definitions - you'll find commentary for every term. The type you know and love from GCFlash Financial Insights. Extracted from back issues of GCFlash.

Acid-Test Ratio Or Quick Ratio

Annual Percentage Yield (APY)



Asset Allocation

Basis Points

Bear Markets

Beige Book

Buy-and-Hold Strategy

Buying Stock on Margin

Capital Gains Tax


Correlation Coefficient

Cross Stock


Dollar Cost Averaging



Earnings Per Share

Future Value

Grace Period


January Effect

Jumbo Certificate of Deposit

Loan-to-value Ratio (LTV)

Mutual Fund Loads

Net Asset Value

Options: Puts and Calls

Preferred Stock


Round Lot

Short Selling

Stock Split

TED Spread

The Rule of 72

The Rule of 120

Treasury Bonds, Bills and Notes

Variable Rate

Yield Curve

Zero-Coupon Bonds

Acid-Test Ratio Or Quick Ratio: The ratio of an enterprise's current assets minus inventories to its current liabilities.

This is a key liquidity ratio which measures the cash, marketable securities (such as stocks, bonds), and receivables of a firm, compared to its current liabilities. The ratio indicates whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. Thus, acid-test ratio = Cash + Marketable securities + Receivables/Current Liabilities.

Though ratios vary among firms, an acid-test ratio of between 0.50 and 1.0 is usually considered satisfactory. However, going under 1.0 could be a hint of some cash flow problems. Ideally, this figure should also be above 1.0 for the firm to be comfortable. That would mean that they could meet all their liabilities without having to sell any of their stock. This would make potential investors feel more comfortable about their liquidity. If the figure is far below 1.0 they may begin to get worried about the firm's ability to meet its debts.

Annual percentage yield (APY): The effective, or true, annual rate of return. The APY is the rate actually earned or paid in one year, taking into account the effect of compounding. The APY is calculated by taking one plus the periodic rate and raising it to the number of periods in a year. For example, a 1% per month rate has an APY of 12.68% (1.01^12 -1).

It is important to take into account the effects of compounding on an investment. While the effects are modest over a single year, over time, the effects of compounding can be quite dramatic. Check out an example I wrote about some years ago on the Financial Insights page on our Web site.

The mathematical equations behind this calculation are complicated and based on calculus, although most modern financial calculators have this function built in. For the consumer, the most important thing to remember is to make sure you are comparing APY's and not APR's or "nominal rates" when evaluating alternative investments. Compare APY's and you need not worry about the differences in compounding, as the APY calculation takes such into account. So in a sense, APY's take all the "math" out of it for you.

Uncle Sam is so fond of APY's that he passed a fairly complicated regulation (Regulation DD) in attempt to protect the consumer when comparing various banking products. You can read more than you probably want at the Federal Reserve's Web site.

Annuity: A contract to make regular payments to a person for life or for a fixed period.

There are a couple different varieties of annuities available. A "deferred" annuity means that the series of annual payments will not begin until a later date. Deferred annuities can be paid for with a single payment or with installment payments in fixed or flexible amounts. An "immediate" annuity means that the income payments start right away. Some annuity contracts are good for life, so if you live long, the insurance company must continue to pay you.

There are two kinds of annuities:

1) Fixed Annuity: The insurance company makes fixed dollar payments to the annuity holder for the term of the contract. This is usually until the annuitant dies.

2) Variable Annuity: At the end of the accumulation stage, the insurance company guarantees a minimum payment and the remaining income payments can vary depending on the performance of your annuity investment portfolio. Variable annuities allow you to invest in a managed portfolio of stocks, bonds, money market funds, or any combination. The performance of this portfolio determines the annual payments you will receive.

Annuities are advantageous for those looking for a relatively low-risk investment with a decent rate of capital appreciation. Annuity contracts have a tax advantage - no federal or state income taxes are owed on the interest or other investment earnings until the money is withdrawn. Should you die, the contract value would pass directly to your designated heirs without probate, although the money wouldn't necessarily escape taxes. Deferred annuities allow you to enjoy the benefits of compounding without worrying about tax implications.

Arbitrage: The simultaneous buying and selling of a security at two different prices in two different markets, resulting in profits without risk. Perfectly efficient markets present no arbitrage opportunities. Perfectly efficient markets seldom exist, but, arbitrage opportunities are often precluded because of transactions costs.

Arbitrage almost sounds like the manipulation of the market price. In a sense, that is correct. Arbitrageurs, or arbs, take advantage of the inefficiencies in the market to make a profit. In doing so, they drive the market price of a security closer together in the different markets, thus rendering them more efficient. Commissions preclude some arbitrage opportunities, since even though a small favorable price differential may exist, the cost of the transaction exceeds the benefit, thus making such opportunities unprofitable. Still, arbitrage occurs often and on a large scale. In some cases, arbitrage facilitates market opportunities where they might not otherwise exist, such as in the case when buyers and sellers are unaware of market opportunities in other markets (a pawn shop is a form of arbitrage). Despite the official definition, which includes "profits without risk", there is SOME risk associated with arbitrage, as in the case of unforeseen or sudden market price moves which may cause a sudden loss during the very brief period in which a security must be held (sometimes seconds). Despite the market manipulation overtures often associated with arbitrage, the practice is good (and even necessary) for financial markets in that it increases their overall efficiency.

Asset Allocation: Generally, asset allocation is a fundamental determinant of risk and return. Below are a couple "rule of thumb" approaches to asset allocation.

The percentage of your money you want to allocate to each type of investment depends upon how far away you are from actually needing to use that money. The longer your time horizon, the more years you have to weather the ups and downs of the stock market and the more you can put in stocks. The other factor that weighs on how much risk you want to take is your tolerance for it.

A. For Risk-Takers:

  • Subtract your age from 115. The answer is the percentage of your total investments you put in stocks.
  • Subtract that number from 100.
  • Divide the remaining amount (up to 100) by 2. The answer is the amount you put in bonds and cash. (The "cash" category doesn't necessarily mean just cash. Instead, think of it as simply very liquid investments, those that can be converted into cash quickly and easily. Many of these actually pay interest, too, such as money market accounts and short-term CDs.)

B. For the Risk-Averse:

  • Subtract your age from 100. The answer is the amount you put in stocks.
  • Divide the remainder by 2. The answer is the amount you put in bonds and cash.

Note: These percentages are meant to apply to your investments overall. If you have some of your money in a 401(k) at work, some in an IRA, and other funds in a discretionary account, the answers you get take all three kinds of investments into account.

Bottom Line: There is no such thing as a perfect asset allocation. The most important thing is to be aware of how much money you have in each of the three asset classes, to change it as life's circumstances change and never put all your money in one asset.

Basis point: In the bond market, the smallest measure used for quoting yields is a basis point. Each percentage point of yield in bonds equals 100 basis points. Basis points also are used for interest rates. An interest rate of 5% is 50 basis points higher than an interest rate of 4.5%.

It does not mean the point from which you start. And although the roots of the term are from the bond world, the term is commonly used when speaking about small proportions of any financially related percentage point.

Why? Percentages are sometimes difficult to work with, especially in small increments. For example, you are considering refinancing your mortgage and ask your accountant for help. She calls back to inform you that she has calculated you could save $42 per month for every 12 BASIS POINT reduction in your mortgage interest rate. She could have said you would save $42 per month for every TWELVE ONE HUNDREDS OF ONE PERCENT reduction in your mortgage interest rate. Accountants are succinct by nature (just like bond traders), not to mention individuals who are known for "few words" - hence born the term basis point.

Bear Markets:

While sitting at a Rotary Club breakfast meeting this morning, a doctor sitting next to me struck up a conversation that went as such:

Doc: So, Mr. Banker, why is the stock market starting to rally?
Me: There is less uncertainty now with the war over, the Fed remains committed to an accommodating monetary policy and deflation fears appear to have abated. Additionally, there is a huge amount of liquidity sitting on the sidelines just waiting to jump back into equities, so the market's rise will likely be a self fulfilling prophesy.
Doc: Huh?
Me: The fundamentals are sound, and the correction, albeit severe, is likely over.
Doc: Huh? All I want to know is how high the DOW is going.
Me (on a limb by now): DOW 10,000 by year end, 12,000 by late 04. (Yes, this was written that long ago. Some references never lose their value. Editor)
Doc: Oh.

He probably felt as I would have felt if he began to explain the necessary enzymes for digestion. All professions get caught up in their own terminology. And lest you think the good doctor knows nothing about finance, he went on to provide me with valuable background information:

"My wife's brother is a broker and manages our money. About 1/8 is invested in stocks, the rest money market. Before the crash we had as much as 70% in stocks, but really got killed, so we 'got out of stocks'." Followed by the question: "When should I start to buy stocks again?"

Doc didn't like my answer. I told him he should have never stopped buying stocks, if in fact, it met his long term investment objectives. By "getting out of stocks" during the recent bear market, he gave up some excellent buying opportunities, and even worse, likely sold near the lows. This is not uncommon. Many, many investors (and brokers) try to "time the market," usually with dismal results. The equity markets are VERY efficient, which means, unless you have inside information (Martha Stewart??), you will likely lose in any attempt to time the market. You should buy a stock much like you would buy any other investment, such as real estate. Is it a good value (price relative to other stocks of its kind)? Do you like its location (industry)? Income potential (dividend performance)? Resale value (P/E Price Earnings Ratio)? At most, try to think of the overall market. The time tested real estate principle, "buy low, sell high," can be applied to stocks as well, just not as most would perceive it. Think of bear markets as an opportunity to pick up quality equities you perhaps couldn't have afforded during the raging bull market of the nineties. The smart investors who picked up cheap shore property twenty years ago have done very, very well.

The bottom line: Equities (stocks) should make up a significant proportion of MOST investment portfolios. And unless you are retiring in the very short term (under two years), don't worry too much about the current market. Over the long haul you will do just fine, as equities (as a group) have consistently returned well over 10% since the end of WWII. They will continue to produce such returns in the future. I advise most investors to buy funds and let the professional money managers worry about the specific stock picks. The reason being that the average investor cannot (or will not) dedicate the time necessary to pick individual stocks. It is work. If you are inclined to try your hand at it, remember some investment advice once offered by my mother: "If you like a stock at $20, you should love it at $10, but it takes guts."

There is a great scene in the 1980's movie Wall Street, where Sir Larry Wildman (Terence Stamp), calling from aboard his yacht, instructs young Bud (Charlie Sheen) on how to gain control of a company whose stock is trading in the 20's (and is being manipulated by Gordon Gekko (Michael Douglas). Sir Larry (thick British Accent): "Buy lightly on the downside (as the price plummets). When it gets to $10, buy it all." Takes guts.

Beige Book: The Beige Book is an anecdotal report on economic conditions drawn mainly from surveys of businesses in the 12 Federal Reserve districts.

Beige Book is one of three books prepared in advance of each Federal Open Market Committee (FOMC) meeting. The other two are the "Green Book," containing the FRB (Federal Reserve Bank) staff forecasts of the U.S. economy and the "Blue Book," which presents the Board members' analysis of monetary policy alternatives. Beige Book is the only one of the three that is released publicly. It is released approximately two weeks before each FOMC meeting at 2:15 PM EST.

The Beige Book is intended to provide FOMC members with an anecdotal look at changes in the economy since the last FOMC meeting. The book is a summary of economic conditions in each of the Fed regions. Each Federal Reserve Bank gathers anecdotal information on current economic conditions in its District.

Generally consisting of reports from bank and branch directors and interviews with key business contacts, economists, market experts, and other sources, the report is primarily seen as an indicator of how the Fed might act at its upcoming meeting. It is published eight times a year, and includes a national summary and the 12 district summaries. The responsibility for compiling the national summary rotates among the Reserve Banks.

To view the beige book, follow this link.

Buy-and-hold strategy: A passive investment strategy with no active buying and selling of stocks from the time the portfolio is created until the end of the investment horizon.

Not a bad strategy for most investors over the long haul. In these uncertain economic times and wild market swings, many investors panic and sell low (some after having bought high). Investors should buy stocks for fundamentally good reasons - (such as the company has a proven track record of stable or rising earnings (profits), or an innovative new product in development - and then stay the course, ignoring the irrational market gyrations. Of course, there is always risk, past earnings are not an iron clad predictor of future earnings and new innovations don't always pan out. Still, over the long haul, equity investments generally have greater returns than other financial instruments (such as bonds, CD's and Money Market Accounts), primarily because of the greater risk involved.

We are all living through this period of staggering short term losses in our portfolios. It is important to remember, however, that if current market values are calculated over a longer period of time, such as ten years, the returns are still impressive. So sit tight and hold on. Patient investors are usually rewarded.

Here's a glance of market history from 1986-present.

Buying Stock on Margin: Purchasing stocks by borrowing some of the purchase cost from the brokerage firm. The margin is the amount of money an investor must invest in the stock. The Board of Governors of the Federal Reserve System sets margin rates in the U.S. market. Currently, you can borrow up to 50% of the stock's purchase price for eligible securities selling at $5 or more per share. A minimum of $2,000 must be maintained in a margin account.

Because it is a leveraged transaction, your potential profit is greater than if you purchased the shares outright. However, your potential loss is also greater. For example, if you put in $500, and the broker lends you $500, then you have $1000 to work with. You then buy 100 stocks at $10 per stock. If the price for the stock increases to $15, and you sell at that price, then you have $1500. You then pay back the broker $500 plus interest, and you still have made approximately $1000, doubling your initial investment of $500. If you had only invested $500 dollars of your own, you would have only got 50 stocks. Then, after selling them for $15, you would have made only $750 dollars, which is only $250 more than your initial investment. However, the risky part is that your losses are also magnified. Had you bought 100 stocks on margin at $10 per stock, and the price had dropped to $5, you would have lost all of your $500, since you have to pay the broker back his $500 dollars. If you had invested only your $500 and bought 50 stocks at $10 dollars and the price dropped to $5, you would have lost only $250.

Another downside is that investors must repay the credit extended by the broker, plus interest. Additionally, if the investor's account goes down in the market value, the broker will issue a margin call, requiring the investor to come up with more money to cover the losses the investor's portfolio has suffered. If the investor is unable to make the margin call, the broker can legally sell off shares of the investor's stock to reduce the broker's chance of loss. Margin calls can force the investor to repay a significant portion of his or her account's loss within days or even hours.

Bottom Line: Having a portfolio with only stocks bought on margin can be very risky, so you should diversify your portfolio to remain above the margin requirement. In short, buying on margin is not for investors who do not want to take risks for extra gains.

Capital Gains Tax: Levies on profits earned by the sale of capital assets, such as stocks, bonds, and real estate.

In the U.S., long-term gains on assets held for one year or more usually are taxed at a lower rate than short-term gains. Gains on capital assets held for less than a year are taxed as ordinary income.

Convexity: Duration and convexity are factor sensitivities that describe exposure to parallel shifts in the yield curve. They can be applied to individual fixed income instruments or to entire fixed income portfolios. Source: Copyright © Contingency Analysis, 1996 - 2000

The concept behind convexity is not as simple as duration, and I won't belabor the math here (see link below). While duration expresses a linear, parallel shift in the yield curve, convexity further defines a security or portfolio's risk exposure to a parallel NONLINEAR shift in the yield curve, as well as its direction (both positive and negative). More simply put, convexity explains risk as it relates to curvature in the yield curve. So what does this mean to the average investor? To be honest, not much. Convexity is a complicated calculation and only has real meaning for a sophisticated institutional investor. That said, it is important to understand that the yield curve can (and often does) move in a nonlinear fashion, i.e. interest rates of various maturities move in the same direction (shift), but at different magnitudes. This causes yield curve "curvature" (hence the name) - yield curves are seldom perfectly linear.

If you want to know more about "the math", check out

Correlation Coefficient: A statistical measure that determines the degree to which two variable's movements are associated.

When two phenomena are varying simultaneously in the same direction or in the opposite direction, and the variation in one is the cause of the variation in other, the two phenomena are said to be correlated.

The correlation measures the relation between two variables, for example between two shares or a share and an index (or in regard to the sector).

The coefficient of correlation indicates whether there is a relation between the price performance of the two variables. The coefficient of correlation may vary between +1 (completely synchronized) and -1 (completely reciprocal as when one stock goes up the other goes down and vice versa). A coefficient of correlation of 0 means that there exists absolutely no correlation between the two variables price performances.

The correlation plays an important part in the portfolio composition. The so-called unsystematic risk can almost be completely eliminated by the distribution of assets in shares with a small correlation and, as a consequence, the risk can be reduced.

So what does all this mean to the average investor? First and most importantly, DIVERSIFICATION reduces risk. Remember the fable about "putting all your eggs in one basket?" Don't. Secondly, you may want to balance your portfolio with stocks that tend to perform differently during economic cycles. For example, in a severe recession, luxury goods such as jewelry, vacations and expensive cars tend to experience a large drop in sales, while discount store often see increased sales. So, you may want to balance those shares of Carnival Cruise Lines (CCL) stock with some shares in Wal-Mart Stores (WMT). Both are good companies, but different. This can get tricky, as many companies build diverse products that offset each other in a down economy. For example, General Motors (GM) builds the Cadillac as well as many different economy models. In such situations, General Motors own product line could have inter-company correlation benefits (both negative and positive). The bottom line: Don't worry too much about the mathematics related to correlation coefficients. Just remember to buy a group of stocks spread across many different industries and perhaps even countries. The diversification will take care of the rest.

Cross Stock: When a broker receives a buy and sell order for the same stock at the same price, and subsequently makes a simultaneous trade between two separate customers.

To "cross stock," a broker combines, or pairs off, a purchase order with a sell order in the same security at the same time and same price but for different customers. For example: Customer A enters a market order to buy 2,000 shares of stock X. At the same time Customer B enters a market order to sell long 2,000 shares of stock X. Both orders are given to the same floor broker, who carries the orders to the stock's crowd. Each stock trades in its own designated location, at a post referred to as "the crowd", which is managed by its assigned specialist.

The broker, if market conditions permit, may cross the orders, i.e., execute both orders at the same time by having customer A buy from customer B. The purpose of the cross is to permit both A and B obtain a better price inside the spread (the difference between bid and the offer).

To cross stock, the broker must make certain of three things:

  • The stock has to be crossed at its assigned trading post and within the quotation prevailing there.
  • The spread must be at least a 2/16 point when the broker enters the trading area. A 1/16 point is not large enough for crossing within the spread. The broker must pair off the orders at a price within the quotation. If the stock were quoted 12-12 4/16, the intended cross would occur at 12 2/16, not at 12. A quotation of 12-12 1/16 doesn't leave any room between the bid and the offer prices to arrange a cross because the trade has to be made at either 12 or 12 1/16; it cannot be made within the quotation.
  • The broker must give either customer a brief opportunity to improve on the price at which the orders are to be crossed or paired off

Dividend: A dividend is an individual's share of any profits that a company distributes to its shareholders.

Companies typically declare and pay dividends quarterly. ALWAYS weigh a stock in terms of its TOTAL return: both growth (price per share) and income (dividends).

An income-oriented investor will seek a stock with a high dividend yield (the dividend yield is the annual dividend divided by the current price) that rises steadily over time, while a growth stock investor will look for a stock with a lower but steadily growing dividend. A growing dividend indicates that the company is fundamentally strong and should turn in a good long-term performance.

When a company you have invested in makes a profit and pays a dividend, you can look at that dividend in two ways: as income or as a vehicle for growth. Reinvesting your dividends instead of using them as income will add fuel to your portfolio growth engine. It's a great way to systematically increase your investment.

You can specify that your dividends are to be automatically reinvested in the same stock that generated them or you can ask that dividends be put in a separate account to purchase other stocks. Either of these will be a productive use of your money. Even better, once you start reinvesting its effortless. The power of compounding is another very strong reason to reinvest your dividends.

Dollar Cost Averaging (DCA): Investing the same dollar amount in securities at scheduled intervals over the long term.

You may have heard that successful investing is all about "timing" - knowing when to get into the market and when to get out. Truth is, it's nearly impossible to correctly "time the market." "Buy low, sell high" may seem like good advice, but even experienced investors find it impossible to pinpoint with any degree of accuracy when the market will go up or down. That's why putting a fixed amount of money into an investment on a regular schedule, regardless of market conditions, is widely recognized as a sound investment strategy. This simple, long-term strategy of regular investments is known as dollar-cost averaging. There are investment plans available that will even set it up so that money is withdrawn automatically every month. You don't have to do anything!

While DCA can't guarantee that your investment will gain or protect you from losses, it can help you buy more shares at a lower price and fewer shares at a higher price. It's a natural way to participate in the market throughout its peaks and valleys, and to keep your emotions from short-circuiting your plan.

This plan is also perfect for the investor who doesn't have that big lump at the start but can invest small amounts regularly. DCA smoothes out the bumps of the market over the long term, and it allows you to take advantage of the ever-elusive market bottom. The "bottom" refers to the lowest point that a security or market hits. It is notable that research shows it may not be good to invest a lump sum by spreading a large amount over an extended period of time. Use this calculator to see this for yourself.

In short, dollar-cost averaging can be an especially effective strategy with funds or stocks that can have sharp ups and downs since it gives you more opportunities to purchase shares less expensively. Perhaps the greatest not-so-subtle benefit of DCA is providing for self-discipline. Participants enrolled in a recurring, automatic investment plan have been proven to have much better overall investment results for the simple reason that the investment is automatic. Most would agree, at some point, the invested funds are no longer missed.

Dow Jones Industrial Average - DJIA: A price-weighted average of 30 actively traded blue chip stocks, primarily industrials but including American Express Co. and American Telephone and Telegraph Co.

Prepared and published by Dow Jones & Co., it is the oldest and most widely quoted of all the market indicators. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks. The DJIA is calculated by adding the closing prices of the component stocks and using a divisor that is adjusted for splits and stock dividends equal to 10% or more of the market value of an issue, as well as substitutions and mergers. The average is quoted in points, not in dollars.

For you and me... it is a convenient indicator (although not absolute) about what the market is doing in general.

An upbeat earnings report from just two companies can spark a rally, which in turn will have an even more positive affect on the market overall. Everyone watches the Dow!

Find out what companies currently compromise the Dow and get real-time quotes

Duration: Duration and convexity are factor sensitivities that describe exposure to parallel shifts in the yield curve. They can be applied to individual fixed income instruments or to entire fixed income portfolios.

The idea behind duration is simple. Suppose a portfolio has a duration of 3 years. The portfolio's value will decline 3% for each 1% increase in interest rates or rise 3% for each 1% decrease in interest rates. Such a portfolio is less risky than one with a 10-year duration. That portfolio is going to decline in value 10% for each 1% rise in interest rates. Convexity provides additional risk information.

So what does this mean to the average investor? The most important point to understand is that, with few exceptions, the value of fixed income securities (such as bonds) are inversely related to market interest rates. For example, let's say you purchase a 10 year bond with a stated interest rate of 10% and 10% is also the market interest rate for a such a security. If, during the ten year term, market interest rates rise to 12%, the value of the bond will fall by a predictable amount given its other risk factors (duration). By the same token, if market interest rates fall to 8%, the value of the bond will INCREASE by a predictable amount (duration). Why? In the latter example, investors will pay a premium for an investment which is yielding a higher than market rate. Conversely, in the former example, investors want a discount for purchasing an investment that is yielding a lower than market rate. After all, the investor could simply invest today in similar investments yielding the current (higher) market rate. Duration is simply the measurement of the magnitude of this price difference relative to movements in general market rates (parallel shifts in the yield curve).

Earnings Per Share (EPS): The portion of a company's profit paid on each share of common stock.

The quality of a stock can be measured in a number of ways, but probably the most popular is the company's earning trend. A company's earnings are its net income or profit, often called its bottom line. Since company earnings usually show up in millions of dollars, it's handy to break that figure down to a smaller number called earnings per share (EPS).

EPS is calculated by subtracting a company's preferred stock obligations from its net profit and dividing the difference by the number of outstanding shares of common stock. For example, if a company earns $50 million in a year and has issued 20 million shares, the earnings per share are $2. This $2 EPS has meaning only if it can be compared with earlier reported figures.

A rising EPS is an indication of greater profitability for the company. A stock becomes a good investment when the company's continued growth in earnings drive it to make more money for its shareholders. You may be able to forgive/ignore a downturn in a year or a quarter due to special problems in the company or general economic change, but ideally you expect an earnings improvement, an upward trend, over time. Strong earnings momentum is likely to be shown by younger, growing companies. More established quality companies will make slight improvements over various quarters, and it's more likely branded as a company with "stable earnings." But there's nothing wrong with stability.

Today stocks are routinely ranked by comparing earnings to expectations and historical trends. The principle is the same: Buy stock in companies with accelerated earnings early, and hope the trend continues.

Future Value: Returns the future value of an investment based on periodic, constant payments and a constant interest rate.

This is one of the most important financial concepts you can learn. Everything has relative value based on some standard, typically expressed in dollars. For the saver/investor, the two key numbers to consider are inflation and the current price/cost of money (expressed as an interest rate). Consider the following example:

You determine that you need $500,000 dollars for retirement in the year 2024. How much will you need to save each month to reach this goal? It may sound daunting, however if you know you can invest your money at a constant rate of 7%, you'll need to save just a little over $800 per month for the next 22 years to reach your goal. This would give you a half million "nominal" dollars, but a half million won't buy nearly as much in 22 years as it does today, so we will have to make an adjustment. If we assume a steady inflation rate of 3%, then a monthly savings amount of about $1,184 would be required. This savings amount would actually yield nearly three quarters of a million "nominal" dollars, which inflation dictates will be needed to have the same value as today's dollar.

If you want to have some fun, play with the interest rates and time periods some. If you invest in higher yielding assets, or you have more time to invest (or a combination of the two) the compounding effect becomes dramatic. For example, if you could earn 12% on your money with the same three percent inflation rate, you would only need to save a little over $600 per month to get the fully inflation adjusted amount. The effect is more dramatic the longer the time period involved (or the higher the rate). Keep in mind higher rates/yield almost always mean higher risk - something to be considered.

Milton Friedman once said, "If there really are seven wonders of the world, then the eighth is compound interest".

The calculus involved in this computation REALLY is daunting. Fortunately, we have a calculator on our website for that.

Grace period: The time period stipulated in most loan contracts and insurance policies during which a late payment will not result in default or cancellation.

Sounds simple enough, however, it is often misunderstood. Many loan contracts provide a "grace period" provision. For example, if your mortgage payment is due on the first of each month, you may not be assessed a late charge or be considered late (technical default) if payment is received by the 15th of the month.

Grace periods were designed to allow for unforeseen mail and processing delays. Rather than deal with such occurrences on an individual basis, it is easier for a lender to allow for an automatic grace period.

The important point to remember is that, in such an instance, your payment is DUE on the 1st - which means if you are mailing the payment - it would need to be mailed several days before the first to arrive on time. True, if you mail your payment on the 10th, it MOST LIKELY will arrive before the grace period elapses, however, you are betting there will be no mail or processing delays.

Many borrowers try to time their payments to arrive just prior to the end of the grace period. Although this practice can allow borrowers to stretch their budget slightly, it also greatly increases the chances of a late payment in the event of a mail or processing delay.

Alternately, the argument is also made that I can continue to earn interest on my money during the grace period, so why pay it one minute early?

The answer, in both cases, is that late charges are expensive. One late charge over the course of the year will more than wipe out any interest benefit of holding on to the money until the last minute. Even worse, your lender will now show you were late X number of times (technical default). This could impact your credit rating and/or the ability to borrow money in the future.

So make your payment by the actual due date, and don't come to think of the end of the grace period as the real due date. To do so is a recipe for late payments.

Index: Statistical composite that measures changes in the economy or in financial markets, often expressed in percentage changes from a base year or from the previous month. Indexes measure the ups and downsof stock, bond, and some commodities markets, in terms of market prices and weighting of companies the index.

From a financial standpoint, an index can be any relative or group measure of value. The Dow Jones Industrial Average (DJIA) as well as the Standard and Poor 500 (S & P) are both a form of index which measure aggregate stock price changes for a group of companies in a broad sector of industries. The Consumer Price Index (CPI) is another widely used index, useful to measure price inflation. In the case of the CPI, the price of individual products rise and fall sporadically, and are hence meaningless for overall planning. If, however, you know the CPI has risen, say 3% in a particular year, then you know you will need a salary increase of something greater than 3% to be better off financially, at least in terms of earning power (due to inflation's negative impact on your earnings). This is valuable information. Similarly, if you own two separate stocks, one that increases in price and the other, which decreases, it would be difficult to make an assessment of which direction (higher or lower) the market is heading. However, if you know the DJIA is up say, 3% for the month and the S & P 500 is up 4% for the same time period, you can be certain the market has been positive over that time period. Again, good information. In short, I love indexes, because they are simple, non-biased measures of the performance of important financial aspects of the economy.

January Effect: Tendency of the stock market to rise between December 31st and the month of January.

The January Effect occurs because many investors choose to sell some of their stocks (which are down) just before the end of the year in order to claim a capital loss for tax purposes. Once the tax calendar rolls over to the next year on January 1st, the same investors quickly reinvest their money in the market, causing stock prices to rise.

Some other explanations have centered around large asset inflows from institutional investors or year-end repositioning of portfolios by professional money managers.

However, if institutional investors (such as retirement plans) were the only reason, then it would be reasonable to see the prices of large-cap and mid-cap stocks rise as much as small-cap stocks in January.

Market history does not support this theory. The January Effect is said to affect small-caps more than mid or large caps as these stocks show the greatest price volatility.

Although the January Effect has been observed numerous times throughout history, it is difficult for investors to profit from it since the entire market expects it to happen and therefore adjusts its prices accordingly.

Another reason the January Effect is considered a non-event is because more people are using tax sheltered retirement plans and thus have no reason to sell at the end of the year for a tax loss.

Jumbo Certificate of Deposit: A certificate of deposit in increments of $100,000.

Many institutions quote different (higher) rates for such products. Institutions justify this practice due to the lower costs associated with servicing higher dollar accounts. In fact, there is a very active jumbo CD market nationwide, with some institutions specializing in such deposits. Typically, jumbo terms are short, ranging from one month to one year. It is important to note, however, that jumbo money is often fickle, or "hot" in that it will be withdrawn quickly for a higher rate someplace else.

The important thing to remember is that if you have at least $100,000 dollars to deposit, don't accept the posted rate. Ask for a jumbo rate which might be substantially higher. One final point: It isn't just for jumbos, as some institutions, although not all, will negotiate a higher rate for smaller deposits under certain conditions. It never hurts to ask!

Loan-to-value ratio (LTV): The ratio of money borrowed on a property to the property's fair market value.

This is a simple, but important concept. Although it can apply to many types of loans, the most common form (and the one discussed here) is for a mortgage loan on real estate. For example, you want to purchase a new home for $100,000. If the bank tells you they will finance a maximum LTV of 80%, then your mortgage will be for no more than $80,000 (you will need to come up with the other 20%, using $20,000 from savings, the sale of another house, etc). Under such a scenario, you the borrower will have a 20% equity stake in the property (the bank will have the other 80% stake).

The "fair market value" is typically established by an appraisal, and can also be the subject of disagreement. Generally, for the lender, the higher the LTV the greater the risk. Why? Because in a foreclosure/liquidation situation, the lower the loan balance, the lower the required sale price, and hence the easier the sale. Additionally, tax/utility liens, legal costs, realtor's fees, etc. can quickly add to the outstanding balance, so a small cushion is desirable. In the residential world, loans with LTV's higher than 80% typically require Private Mortgage Insurance (PMI) to help offset some of the lender's increased risk. (PMI will be the subject of a future Financial Glossary).

Is it harder to attain a loan for an LTV higher than 80% and are there any loans available? The answer is yes and yes. I already mentioned the need for PMI on high leverage loans, but you, as the borrower, may pay a higher interest rate or get other terms which are less favorable (banks will demand this higher return to offset their increased risk). But don't despair, as the mortgage lending business is highly competitive, and many, many lenders have various programs available to borrowers who simply have less money to put down. In recent years, many lenders have initiated "first time home buyers" programs which allow for as little as a few percent of the purchase price coming from the borrower. The bank is counting on the future earning potential of the borrower, and in most cases, the price of the home will appreciate, so the bank's equity position will gradually improve.

Although it violates some of the past rules of thumb for prudence (from the bank's perspective), in recent years, existing home owners have been able to borrower as much as 150% of the value of their home through various home equity loan programs. In such a case the LTV would be 150%.

Mutual funds have two basic types of costs associated with them, loads (if applicable) and operating expenses.

A load is a commission or sales fee charged on the purchase or sale of the mutual fund shares. Funds sold through financial advisors generally carry front-end loads of up to 8.5 percent, which are taken off the top of your investment. For example, if you invest $1000 in a fund charging a 5.0% front-end load, only $950 gets invested in the fund. Some funds carry redemption charges of up to 6 percent, called back-end loads, when selling (redeeming) fund shares. Back-end loads effectively reduce the amount that gets paid out to you. Some funds have conditional back-end loads, meaning that if you leave the fund before some prescribed time period, say one year, you incur a redemption fee. Funds do this to avoid hurting the remaining shareholders and to defray operating costs.

Funds that carry no such loads are known as no-load funds. It's easy to spot the no-load funds in the mutual fund tables in the newspapers or on the Web sites. They have an "NL" in the offer price column. That means that the fund is bought and sold at the price listed in the NAV column. All mutual funds are traded based on their net asset value (NAV). A fund with an offer price that is identical to its NAV is either a no-load fund or a load fund carrying a contingent deferred sales charge.

A fund's operating expense ratio (OER) is an important term to remember. It is the ratio of the fund's annual operating expenses (fund investment advisors fees, legal and accounting services, phone charges and other administrative expenses such as printing and postage), management fees and any 12b-1 fees relative to its average net assets. The 12b-1 fee basically is money deducted for marketing and distribution expenses including commission to brokers. The law states that such fees cannot exceed 0.75% of the funds average net assets per year. No-load funds may not charge more than 0.25%. OER is expressed in annual percentage terms and deducted from fund's total returns before posting the day's NAV. It's critical to understand that when you see a fund's total return, expenses have already been deducted. These expenses are referred to as a fund's expense ratio. For example, assume Fund X and Fund Y both earned a gross total return of 10 percent. Fund X has an expense ratio of 1.5%, while Fund Y has only a 0.5% expense ratio. When total returns are posted by the fund company, Fund X will show a (net) total return of 8.5% while Fund Y shows a 9.5% return, so it becomes essential to know your fund's expense ratio.

Bottom Line: Consider the operating expense ratio and other charges associated with the funds while comparing their performance and/or making a choice.

Net Asset Value (NAV): The market value or price of one fund share

The Net Asset Value (NAV) is the market value (securities held by the fund minus any liabilities) of the mutual fund portfolio divided by the number of shares it has outstanding. (If the fund is a no-load fund, i.e. there is no commission to buy or sell fund shares, the NAV is the price per share of the mutual fund.)

A fund with an offer price that is identical to its NAV is either a no-load fund or a load fund carrying a contingent deferred sales charge.

If a fund had net assets of $50 million and there are one million shares of the fund, the price per share (or NAV) is $50.00.

When a fund has a sales charge, called load, the price you have to pay is called the offering price and that's equal to the NAV plus any sales charges (loads). For example, if a fund's NAV was $100.00, and had a 5 percent load, the offering price would be $105.00, meaning you have to pay $105 to invest $100. Funds sold through financial advisors often have sales charges. As for no-load funds, the NAV and offering price are the same.

A fund's NAV may change every day to reflect changes in the value of its portfolio holdings, which in turn respond to changing market conditions. Further, mutual funds are open-ended, meaning they allow for daily purchases and redemption, which affects the total number of shares outstanding.

Fund companies typically calculate fund's NAV at the end of the day after the markets have closed. This allows the fund company to value the holdings in each fund and determine the total number of shares in which to base the NAV calculation. NAV are usually available two to three hours after market close. Investors can track fund performance by looking at the change in NAV, like they would if they were tracking stock performance using stock prices.

NAVs are helpful in keeping an eye on your mutual fund's price movement, but NAVs are not the best way to keep track of performance. The reason for this is mutual fund distributions. Mutual funds are forced by law to distribute at least 90% of its realized capital gains and dividend income each year. When a fund pays out this distribution, the NAV drops by the amount paid. This is important because an investor may worry when they see their fund's NAV drop by $3 even though they haven't lost any money (the $3 was paid out to the shareholder).

Options: Puts and Calls: A stock option is a contract which conveys to its holder the right, but not the obligation, to buy or sell securities of the underlying security at a specified price on or before a given date. After this date, the option ceases to exist. The seller of an option is in turn obligated to sell (or buy) the shares to (or from) the buyer of the option at a specified price upon the buyer's request.

Each contract generally represents 100 shares of the underlying stock, there are no partial contracts.

The option calls can be structured as two option types: PUTS and CALLS.

Puts, or "put options" as they are otherwise termed, are option contracts that enable the purchasing put option holder to effectively sell his underlying stock at a predetermined price. Put option holders anticipate a decline in the price of the underlying stock. To take advantage of expected decline in stock, the investor purchases a put option for the right to sell or exercise it, hopefully only after the stock turndown has occurred. If, however, the value of the underlying stock rises after the put option has been purchased, the losses for the investor are limited and he cannot lose more than the premium price paid for the option.

Generally speaking, the values of the underlying stock and put option contract are inversely related. The put option contract's value rises as the underlying stock's value drops and vice-versa.

Those who engage in put writing, by selling the put and getting paid for it, try to take advantage of their expectation that, after such sale, the value of underlying stock will rise. If the stock does rise in price, then the put will not be exercised and the put writer profits.

Calls or "calls options" are just the reverse. They are option contracts that allow the option holder to purchase from the seller (writer) at the strike price (the price at which the underlying stock will be bought or sold if you exercise the stock option), a security for a predetermined amount of time. If the buyer exercises his call option, then the seller must sell to the buyer the underlying stock at the strike price. The seller is obligated to do this if the exercise demand is made by the buyer, even without regard to what market value the underlying stock is currently trading at the time of exercise.

Generally speaking, the values of the underlying stock and put option contract are directly related. If the call option contract's value will decrease, the underlying stock value also decreases and vice-versa. The writer of a call anticipates that the underlying stock value will fall or remain constant.

Most put and call options are traded on the American Stock Exchange in New York, the Chicago Board of Options Exchange and the Pacific Exchange.

Puts and calls are considered a short-term approach to investing, but to build up a solid asset base these strategies have a limited value. In order to make a profit, you have to be right more often than not over periods of just a few months, which is tough. In short, be very comfortable with investing before you try option strategies. Although usually thought of as a form of speculation, it should be noted that skilled investors often use CALLS and PUTS to dilute market risk as a form of hedging. For example, an investor with ownership of a particular security obviously hopes the share price rises. That same investor may buy some PUTS on that very same security, so in the event the security price falls, the loss suffered in share price is at least partially offset by the profit on the PUTS. Sort of a consolation prize. If the stock price does indeed rise (as hoped), the PUTS expire and the investor is only out the premium paid for the PUTS. Of course the profit gained from the increased share price remains and should, if properly structured, far exceed the PUT premium. This is a form of leverage, and although complex and not for the novice investor, the use of CALLS and PUTS can be a successful method of gaining "market insurance" and yet another tool for the savvy investor.

Preferred Stock: Stock that acts a lot like a bond but confers an ownership stake in the company.

Preferred stock gives its owners preference (hence the term "preferred") in the payment of dividends and an earlier claim on company's assets than common stock if the firm is forced out of business and its assets sold. Normally, preferred stock does not include voting rights in the firm. Preferred stock is frequently referred to as a hybrid investment because it has characteristics of both bonds and stocks.

Preferred stock dividends differ from common stock dividends in several ways. Preferred stock is generally issued with a par value that becomes the base for the dividend the firm is willing to pay. For example, if a preferred stock's par value is $100 a share with a dividend rate of 7%, the firm is committing to a $7 dividend for each share of preferred stock the investor owns. An owner of 100 shares of this preferred stock is promised a fixed yearly dividend of $700. The owner is also assured that this dividend MUST be paid before any common stock dividends can be issued.

Preferred stock is thus quite similar to bonds as both have a face value and both have a fixed rate of return. So how do bonds and preferred stock differ? The companies are legally bound to pay bond interest and to repay the face value of the bond on its maturity date. In contrast, even though preferred stock dividends are fixed, they do not legally have to be paid, and stock never has to be repurchased. Though both stocks and bonds can increase in market value, the price of stock generally increases at a higher percentage than the price of bonds. Also, the market value of both could go down.

Preferred stock can have special features that do not apply to common stock. For example, like bonds, preferred stock can be callable. This means a company could require preferred stockholders to sell back their shares. Preferred stock can also be converted to shares of common stock. An important feature of preferred stock is that it's often cumulative i.e., if one or more dividends were not paid when due, the missed dividends of cumulative preferred stock will be accumulated and paid later. This means that all dividends, including the back dividends, must be paid in full before any common stock dividends can be distributed.

In many ways, the insulation preferred stock gives shareholders can seem to be very attractive, although individual investors have to pay taxes on the full dividend received. Why, then, would anyone choose common stock over preferred stock? Preferred stock does not participate in a corporation's growth. Most investors want to reap the benefits of a company's growth over the security of preferred stock. In addition, preferred stock in a company usually carries a higher price tag than common stock in the same company.

Prospectus: A formal legal document describing details of a corporation for a proposed offering or existing business.

Once you spot a fund that you think might suit your purposes, call the mutual fund company or your broker and ask for a prospectus. Every mutual fund is required to publish a prospectus and to give investors a copy, free of charge. The prospectus lists the fund's goals, restrictions, advisers, and fees.

You should examine the prospectus carefully before you invest. There are key pieces of information you should look for:

  • The fund's investment objectives: Make sure that, at the start, the fund's investment goals are in keeping with your own investment goals and with your tolerance or risk. With mutual funds, as with other investments, the higher the risk, the greater the potential reward.
  • The kind of securities the fund holds: Look for an account of the kinds of transactions the fund may execute, and the types of securities it can buy or sell. The portfolio may include money market securities, bonds, stocks, precious metals, options, warrants and hedge transactions. You may already know this before you read the prospectus, but it's wise to double-check and make sure the fund is investing in what you really think it is.
  • Investment minimums: A stock fund usually requires an initial investment of $1,000 to $5,000.
  • Sales charges and fees: Make sure the fund is no-load. A true no-load fund imposes no front or back-end sales charges. Every mutual fund, whether load or no-load, charges an annual fee to pay its portfolio manager and cover other fund expenditures. This fee is quoted as a percentage of the fund's average annual assets and is often called the fund's operating expense ratio. In addition, some funds take an extra bit to cover the fund's advertising and promotion expenses. Called a 12b-1 fee after the regulation authorizing it, this fee has no regulatory cap: some funds charge 1 percent or more. These fees are not paid directly by the shareholder but are taken out of the fund's current income before distribution to the shareholder. So the lower the fund's fees, the more the shareholder benefits.
  • When earnings are distributed: Funds distribute dividends and realized capital gains either monthly, quarterly, semi-annually or yearly. It may not be a good idea to invest in a stock fund late in the year, since you could receive a large distribution of capital gains on which you would owe taxes very soon. Postpone investing if it would adversely influence your tax situation.

Bottom Line: Take the time to understand the risks before investing in a company. By reading a few pages, you could be saving yourself thousands of dollars.

Round Lot: A trading order typically of 100 shares of a stock or some multiple of 100.

The various stock exchanges are geared for trading shares of stock in multiples of 100. Typically, the minimum investment in a company would be for 100 shares. For example, if a company's stock, say Cisco Systems (CSCO), is selling for $20.35 per share (today's close), a round lot of 100 shares would cost you $2,035.00 (plus commission).

Commission schedules are set up based on multiples of one hundred as well, so while some brokerage firms will allow an investor to buy less than one hundred shares (called an odd lot), the commission is usually substantially higher. In reality, in such cases, the brokerage firm is buying the round lot and breaking it up between investors OR simply adding any leftover shares to their own portfolio. This special attention is the reason for the higher commission charge.

The bottom line: If you wish to invest in a stock, make sure you can afford at least 100 shares (one round lot). Buying in smaller quantities will likely cause the commission to be prohibitive when calculated on a per share basis.

There are some exceptions, as it has been fashionable in recent years to buy a single share of stock for a wedding present, birthday gift, etc. A neat idea, and the gift can grow over time. I received a single share of JR Wrigley (WWY) as a wedding gift. Although this would have equated to about an $80 gift at the time, my wife and I continue to enjoy, every single year, the CASE of chewing gum sent to each stockholder by the company. This dividend outweighs any cash dividend or price appreciation of the underlying stock. It is indeed a gift that kept giving until the company was acquired by Mars, Inc.!

Short Selling: The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller.

This technique is used to take advantage of an anticipated decline in the price of stock or other security by reversing the usual order of buying and selling. Here's how it works: The investor borrows stock from the broker and immediately sells it. Then, if the investor guessed right and the price of the stock does indeed decline, he can replace the borrowed shares by buying them at a cheaper price. The profit is the difference between the price at which he sells the shares and the price at which he buys later on.

It sounds like a great plan, but the downside is pretty serious. If you're wrong about a particular stock and it goes up instead of down, you owe the broker for the new cost of those shares. And there's no telling how high those shares can go. When you own a stock outright, the worst -- the very worst -- that can possibly happen is that the stock goes to zero, in which case you LOSE the TOTAL amount you invested in that stock. But, when you SELL SHORT, you can LOSE ALL your money. Your potential loss is unlimited, because there's no limit to how high a stock price can go.

To sum up, short selling is a tricky business, involving borrowed stock and relying on an investor's knack for spotting an overvalued stock, something that takes quite a bit of experience to be able to do. In fact, there's nothing intrinsically wrong with it. However, beware because of its VERY HIGH/UNLIMITED RISK. It is definitely an only-for-the-pros endeavor, requiring a great deal of experience, diligence and attention.

Stock Split: The division of a company's existing stock into more shares.

Companies and brokers prefer to have stock purchases conducted in round lots, i.e., purchases of 100 shares at a time. However, investors often buy stock in odd lots, or purchases of less than 100 shares at a time. The reason is that many investors cannot afford to buy 100 shares of a stock in companies that may be selling for perhaps as high as $150 per share. Such high prices often induce companies to declare stock splits; i.e., they issue two or more shares for every share of stock that's currently outstanding. For example, if XYZ stock were selling for $150 a share, XYZ could declare a 2 for 1 split. Investors who owned 1 share of XYZ would now own 2 shares; each share, would now be worth only $75.

As you can see, there is no change in the firm's ownership structure or the investment's value after the stock split. If the value doesn't change, why would a company split their stock? The first reason is psychology. As the price of a stock gets higher and higher, some people feel the price is too high. Splitting the stock brings the share price down to a more attractive level. The actual value of the stock doesn't change, but the cheaper stock has psychological effects that might attract new investors. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before. In reality, the total worth of the new amount of shares equals their previous total worth.

A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their industry. The primary motive is to make shares seem to be more affordable to small investors even though the underlying value of the company has not changed.

A stock split usually results in a share price increase because many small investors think that the stock is more affordable and buy it. Another reason for the price increase is that a stock split provides a signal to the market that the company's share price has been increasing and people assume that this growth will continue in the future.

A final motivation for splitting the stock is to increase a stock's liquidity, which increases with the number of outstanding shares a stock has. For example, in a 2-for-1 stock split, every shareholder with one stock is given an additional share. If a company had 10 million shares outstanding before the split, it will have 20 million shares outstanding after a 2-for-1 split.

Visit to view the Stock splits calendar.

Bottom Line: Buy a stock because you think it's a good value, not because it's going to split.

TED spread: The difference between the rate for Treasury Bills and the rate for Eurodollar Bills.

The TED (Treasury over Eurodollar) spread between T-bill and Eurodollar futures is one relationship among interest rate contracts that is most actively watched by traders. Treasury bill and Eurodollar contracts trade with the same periods and the spread can be traded. The spread reflects investor's views of the relative credit quality of the U.S. Treasury and the highest quality international banks. One factor that can influence the spread is that, historically, in times of international crisis or uncertainty, investors have rotated funds into U.S. Treasuries. It's the 'flight to quality' we hear mentioned so often.

Essentially, the TED Spread is the rate at which a U.S. Treasury Bill is trading minus the rate at which the Eurodollar future is trading. For example, assume that the rate of a U.S. T Bill is 94.20 (implied discounted rate of 5.80%) and the Eurodollar future is trading at 93.10 (implied Eurodollar deposit rate of 6.90%). In this case the TED Spread would be 94.20 - 93.10 = 1.10. The TED Spread would be quoted at 110.

The resulting price discrepancy is an indicator of credit risk. An increasing TED spread is thought to indicate increasing risk, while a decreasing TED spread is thought to indicate decreasing risk.

One of the attractive aspects of the TED spread is its simplicity. An expectation that the spread will widen justifies buying the spread (i.e., buying Treasury bill futures and selling Eurodollar futures), while an expectation of a narrowing of the differential justifies selling the spread.

The Rule Of 72: A simple mathematical formula that quickly calculates the amount of time it takes an investment to double.

The rule of 72 comes in handy when you're talking about time and money. This simple formula gives you an idea of approximately how long will it take to double your investment (money) at different rates of return.

Simply divide the number 72 by your rate of return. For example, you want to know how long will it take to double your investment at 8%. Divide 72 by 8 [72/8 = 9]. Therefore, it will take approximately 9 years to double your investment at an 8% rate of return. Similarly, an investment returning two percent will double your money in 36 years (72/2 = 36), while one returning 6 percent will double your money in just 12 years (72/6 = 12).

Conversely, if you want to double your money in a certain number of years, divide 72 by the number of years you want your money to double in [e.g., if you want to double your money in 12 years, take 72 and divide it by 12]. This will give you the interest rate you must earn in order to achieve your goal.

A simple tool, yet you will be surprised at how often you use it.

The Rule Of 120: A quick way to calculate what proportion of your portfolio should be invested in stocks.

The proportion of your portfolio that should be invested in stocks will depend on a number of factors; including your investment objectives, your overall financial circumstances and your current tax bracket. The Rule of 120 is a quick way to come up with a ballpark figure for a long-term, admittedly aggressive proportion.

Simply deduct your age from 120. The figure you come up with is the proportion. For example, if you are 35 years of age, subtract 35 from 120. The answer is 85 i.e., you should have 85% (120 - 35 = 85) of your investment portfolio invested in stocks. Similarly, if you are 50 years of age, you should have 70% of your investment portfolio invested in stocks or stock mutual funds.

The rule is designed with the principle that, in general, when we are younger we need to focus on capital growth and can afford to take more risks. As we grow older, our need tends to shift away from capital growth and move towards greater stability of principal. Theoretically, as we age, we are less able psychologically and/or financially to handle the losses that might result from a severe bear market.

Again, this a just a quick way to figure out a guideline of what might be an appropriate percentage amount for you to invest in stocks or stock mutual funds. The best "asset allocation" plan will vary from individual to individual.

Treasury Bonds, Treasury Notes And Treasury Bills: Securities issued by the U.S. government and its agencies are the choice of many conservative investors concerned with the preservation of their capital as they are backed by the 'full faith and credit' of the U.S government. So if you hold the investment until maturity, the possibility of losing the face value of the money you invest is zero. Additionally, interest earned on them is exempt from state and local taxes. Federal taxes, however, are still due on the earned interest. There are three types of marketable securities issued by the U.S. Treasury. These are distinguished by the amount of time from the initial sale of the bond to its maturity.

Treasury Bonds: These securities have the longest maturity of any bond issued by the U.S. Treasury, from 10 to 30 years. The 30-year bond is also called the "long bond." Denominations range from $1000 to $1 million. T-bonds pay interest every 6 months at a fixed coupon rate, i.e. the interest rate paid on the face value of the bond. These bonds are not callable, but some older T-bonds available on the secondary market are callable within five years of the maturity date.

The government sells Treasury bonds by auction in the primary market, but they can also be purchased through a broker in the secondary market. A broker will charge a fee for such a transaction, but the government charges no fee to participate in auctions. Treasury bonds are marketable securities, meaning that they can be traded after the initial purchase. Additionally, they are highly liquid because there is an active secondary market for them. Prices on the secondary market and at auction are determined by interest rates.

Treasury bonds issued today are not callable, so they will continue to accrue interest until the maturity date. Investors who wish to participate in auctions and purchase Treasury securities directly from the Federal Reserve Bank can open a Treasury Direct Account. There are no fees associated with the account unless it contains over $100,000, at which point a very small maintenance fee is incurred.

Treasury Notes: T-notes have maturities between 2 and 10 years. Denominations range from $1000 to $5000 and are determined by the amount of time to maturity. Like T-bonds, these securities pay interest semi-annually at a fixed rate. The notes are not callable prior to maturity.

Treasury Bills: Treasury bills, sometimes called T-bills, are short-term, highly liquid investments available in maturities from three months to one year. They are sold at a discount and return their full face value at maturity. The interest you earn is the difference between the face value of the bill (minimum $10,000) and the purchase price.

Variable Rate: An interest rate that changes on a periodic basis.

Variable rates are often used for mortgages, credit cards and certain other kinds of loans. The change is usually tied to movement of an outside indicator, such as the prime interest rate, that reflects changes in market rates of interest. Movement above or below certain levels is often prevented by a predetermined floor and ceiling for a given rate. It is also called adjustable rate.

A fixed-rate mortgage is straightforward and the most familiar mortgage. The borrower knows from the beginning what the interest rate will be for the entire duration of the mortgage, and the monthly payments due are likewise fixed. The other is the adjustable-rate mortgage (ARM). Its rate changes from year to year to reflect the interest rate changes. If rates are falling, your rate will also drop and vice versa. Most ARMs have limits, or caps on rate changes. When interest rates are rising rapidly, caps protect you from huge jumps in your monthly payments. Most ARMs have both periodic ceilings (limiting the increase from one adjustment period to the next) and the lifetime ceilings (limiting the overall interest rate increase over the term of the loan).

Fixed-rate mortgages are good because they come with no surprises. But for this benefit, you'll likely pay a slightly higher rate than you would with an ARM. Fixed-rate mortgages are good for people who enjoy stability. They're also especially attractive during periods when interest rates are low. At such times, fixed-rate mortgages permit you to lock in low rates for many years. Conversely, if the prevailing interest rates are high, an ARM might make more sense if you think rates are more likely to fall than rise. In addition, since ARM rates are typically slightly lower than fixed rates, they permit borrowers to borrow a little bit more. ARMs are often recommended for those who will only be in a house for a few years as the rate is not likely to change much during that time.

Yield Curve: The graphic depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

And it is not just about bonds. Under normal circumstances, investors demand a higher return for instruments of longer maturity - which equates to a gently up sloping yield curve. If you think about it, this makes sense, since investors are tying up their money for a longer period of uncertainty. A three month security means their money will be freed up again relatively soon (low risk). Buy a twenty year bond? A lot can (and usually does) happen in twenty years (higher risk).

That's the norm. A yield curve can also be "steep," meaning long term rates are much higher than short term rates (often seen in the first months of an economic recovery), or "flat," meaning there is no difference in short versus long term rates (often precedes an inverted curve). A humped yield curve is some combination of both as pricing differences between different maturities cause the curve to spike up and down.

Perhaps the most infamous of the yield curve shapes is the "inverted" yield curve. This refers to a situation when short term maturities are actually priced HIGHER than long term maturities. This is not a normal situation, but does occasionally occur (usually immediately before a recession). Why would investors irrationally require LESS return for longer maturities? Only in a period when they think rates (and the economy) are heading EVEN LOWER and they attempt to "lock in" the higher rates now.

One economist has mused that yield curves are a lot like economic tea leaves. Very valuable, if properly read. There may be some truth to this, as the last five U.S. recessions have been preceded by an inversion of the yield curve. What is important for most people to remember is that the price of money is measured in time.

Zero-Coupon Bonds: A security that does not give periodic interest payments.

Zeros get their name from the fact that they pay no interest at all until maturity. The lack of income along the way means that zeros must sell at a huge discount from face value in order to attract any investors, and the further away the maturity date, the bigger the discount must be. The interest paid on the bond is the difference between the discounted price and the bond's full face value (which is paid to the investor at maturity). In other words, issuers compensate investors for their patience by issuing zeros at steep discounts from their redemption value. For example: A 30-year zero with a face value of $10,000 and a yield to maturity of 10% would sell for $535 today.

This sort of predictable payout makes zeros ideal for a conservative college savings program because the maturities can be timed to coincide with the year college bills become due. On top of that, zero-coupon treasury bonds come with no risk of default.

There is a catch, however. Even though zeros pay no annual interest, at tax time you have to act as if they do. As the "phantom" interest accrues year by year, you must pay income tax on it. This heads off a big tax bill at maturity, but it's undesirable to pay tax on income you won't receive for years. Zero-coupon municipal bonds, which pay tax-free interest, are a sure way around this annoyance.