Arbitrage. The simultaneous purchase and sale of a security or pair of similar securities to profit from a pricing discrepancy.

Average gain. The average percentage gain in periods with a positive return.

Average loss. The average percentage loss in periods with a negative return.

Beta. A measure of how much the value of a security or portfolio of securities moves in relation to the average performance of the stock market for a given period of time. In this book, beta is calculated by comparing the price movements of the HFR indices with the S&P 500 index of blue-chip stocks.

Boom-bust sequence. The process by which the value of an instrument or class of instruments is pushed to a valuation extreme, reverses itself, and crashes back to a more normal valuation.

Call feature. A feature that allows the issuer to redeem a bond before it matures.

Cash merger. A deal in which the acquiring company pays cash for the target company.

Catalyst. A near-term event, such as a press release or a new product launch, that will heighten investor interest in or change the market’s perception of a company.

Collateral. Cash or very liquid securities that are held as a deposit on borrowed securities.

Conversion value. The value of a convertible bond if it were to be converted to common stock.

Convertible arbitrage. The simultaneous purchase of a convertible bond and sale of the underlying common stock to profit from a pricing discrepancy.

Convertible bond. A corporate bond issued with a corporate bond yield and a conversion feature that allows the holder to convert the bond into a fixed number of shares of the issuing company’s common stock.

Core positions. Long-term positions in growth stocks from which managers derive the majority of their profits.

Coupon. A bond’s fixed interest payment.

Distressed securities. The securities of companies that are experiencing financial or operational difficulties. Distressed situations include reorganizations, bankruptcies, distressed sales, and other corporate restructurings.

Duration. A measure of how sensitive a bond’s price is to a shift in interest rates. In general terms,

Emerging market. A market that is changing rapidly at the macroeconomic and company level, usually because it is restructuring on the free market model.

Equity-market-neutral portfolio. A portfolio composed of balanced exposure to long stock positions and offsetting short stock positions.

Event analysis. The process by which an analyst assesses the probabilities of all the possible outcomes of a corporate event.

Exit catalyst. An event on the horizon that the distressed securities specialist expects to change the market’s perception of, and therefore the value of, the distressed company.

Far-from-equilibrium condition. An unusual macro situation characterized by persistent price trends or extreme price valuations of particular financial instruments.

Fixed-income securities. Securities that entitle the holder to a series of fixed payments at predetermined future dates.

Fundamental value. The intrinsic or “real” value of a security, which reflects both tangible and intangible company assets.

Gain period. The percentage of periods with positive or neutral returns.

Global investors. Investors who consider emerging markets to be one potential asset class, along with developed markets and fixed-income securities, and who allocate capital to each asset class when they believe that it offers attractive potential returns compared with other asset classes.

Growth stock. A stock that an invest or believes will appreciate because the company’s output and earnings will grow.

Hedge ratio. The number of shares that the convertible arbitrage specialist decides to sell short out of the total number possible.

Hedging. The taking of positions to offset changes in economic conditions falling outside the core investment idea, such as purchasing a long position and a short position in similar stocks to offset the effect any changes in the overall level of the equity market will have on the long position.

High-period return. The highest rate of return for a one-month period.

Indicators. Financial data used to forecast the future performance of a company.

Inflection point. The point at which an extreme valuation reverses itself, usually marked or signaled by a major policy move.

Investment value. The value of the bond component of a convertible bond.

Leverage. The practice of borrowing to add to an investment position when one believes that the return from the position will exceed the cost of the borrowed funds. Both companies and investors can use leverage. A company that takes on more debt than its ability to generate cash warrants is said to be overleveraged.

Leveraged buyout. An often hostile situation in which the acquiring company buys out the target company by using borrowed funds.

Liquidation. The sale of assets for cash, sometimes to pay off debt.

Low-period return. The lowest rate of return for a one-month period.

Mark to market. To determine the price one can get today for currently owned securities.

Market exposure. The amount of portfolio that is exposed to market risk because it is not matched by an offsetting position.

Market inefficiencies. Pricing disparities caused by a lack of information about a market or company or by a distortion of the information that is available.

Market-neutral portfolio. A portfolio composed of equal dollar amounts of long stock positions and offsetting short stock positions.

Maturity date. The date on which a bond is redeemed (a 5-year bond comes to maturity five years after it is issued).

Maximum drawdown. The peak-to-valley percentage change in the value of some initial investment in a fund.

Mortgage-backed securities. Securities that represent an ownership interest in mortgage loans made by financial institutions (such as savings and loans, commercial banks, or mortgage companies) to finance the borrower’s purchase of a home.

Net market exposure. The percentage of the portfolio exposed to market fluctuations because long positions are not matched by equal dollar amounts of short positions. In general terms,

One-period arithmetic standard deviation. The distribution of performance over any single period (one month) for a given set of noncompounded returns.

One-period geometric average. The hypothetical rate of return for a single period (one month), derived from the compounded geometric return of a time series.

Overleveraged company. A company that has a large amount of debt relative to its ability to pay interest on that debt.

Par value. The face value of a bond, or the amount that it is redeemed for at maturity.

Prepayments. Payments to repay a mortgage loan ahead of the scheduled repayment date.

Relative value. The value of a particular security relative to that of other similar or related instruments, such as the same company’s other debt instruments.

Risk-free interest rate. The 3-month U.S. Treasury bill rate used in calculating the Sharpe ratio. The statistics in this book assume a 5 percent risk-free rate.

Sector. A group of companies or segment of the economy that is similar in either its product or its market, for example, health care, biotechnology, financial services, or information technologies.

Securities market infrastructure. The means of making investments and tracking financial information, including accounting standards, availability of trading and financial information, and sophistication of available financial instruments.

Senior debt. A class of debt securities whose holders a company is obligated to pay off before the holders of its other securities, in the case of bankruptcy.

Servicing debt. Paying the interest and principal due to bondholders.

Sharpe ratio. The reward-to-risk ratio, discounting for the risk-free interest rate. It is calculated as follows: Annualized geometric performance - Risk-free interest rate annual standard deviation.

Short interest rebate. The interest earned on the cash proceeds of a short sale of stock.

Short selling. The practice of borrowing a stock on collateral and immediately selling it on the market with the intention of buying it back later at a lower price.

Significant corporate events. Major public events, such as mergers, bankruptcies, and spin-offs, that have the potential to dramatically change a company’s makeup and as a result the valuation of its debt and equity instruments.

Speculator. An investor who makes large directional bets on what financial markets will do next.

Spread. The difference between the prices of two comparable or related securities. Spreads are measured in basis points. One basis point equals 1/100 of a percent. For example, corporate bonds of a comparable maturity and comparable coupon rates will have higher yields than Treasuries to reflect greater default risk, so their yields are often quoted as a spread above the Treasury rate. The more risky the bond issue, the larger is the spread.

Static return. Returns, such as interest income from coupon payments and short interest rebates from short sales of stock, that are unaffected by price fluctuations of the underlying securities.

Stock selection risk. Exposure to uncertainty about the future valuation of a particular stock.

Stock swap merger. A deal in which the holders of the target company’s stock receive shares of the acquiring company’s stock rather than cash.

Strategic acquisition. A generally noncompetitive situation in which the acquiring company has a good business reason for the merger, such as expanding product capability.

Structural anomalies. Greater-than-expected price discounts that can be attributed to nonmarket or nonrational technical factors.

Systematic or market risk. Exposure to uncertainty about systematic rises and falls in stock market prices that affect the prices of all stocks in a market or sector.

Systematic risk factors. Factors, such as interest rates or the price of oil, that have the ability to affect systematically the valuation of a whole range of stocks if they change.

Time horizon analysis. The examination of the time frame for completion of a corporate event (if the event is going to happen, then when will it occur?).

Trading positions. Opportunistic positions designed to take advantage of short-term market mispricings and inefficiencies rather than hedge against market decline.

Warrant. The stock conversion component of a convertible bond.

Within the hedge. A phrase used to describe that portion of an equity hedge portfolio in which long positions are matched by equal dollar amounts of short positions.

Yield. The single investment rate that sets the present value of all a bond’s future cash payments equal to the price of the bond.