Personal Investment: financial planning in an uncertain world

by Mariana Mazzucato, Jonquil Lowe, Alan Shipman and Andrew Trigg


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Absolute return

An investment target expressed as a percentage return, or return above the risk-free rate, rather than a comparison with peer or benchmark performance. See also relative return.


Active investor

An investor who seeks to outperform a specified investment benchmark.


Adverse selection

The disappearance of profitable or trustworthy buyers or sellers from a market, due to prices or rules set, leaving only less profitable or less trustworthy participants.


Aggressive shares

Shares in companies with high expected growth but high risk, compared to their relative benchmark (beta higher than 1). See also defensive shares.


Allocative efficiency

The allocation of resources to their best possible use.



The amount by which a portfolio has outperformed (or underperformed) its benchmark by taking on specific risk.


Alternative investment market

A London-based ‘second tier’ stock exchange that offers simplified listing for shares in smaller or newer companies, usually regarded as riskier than those on the main market. See also London Stock Exchange.


American-style option

A share option that can be exercised any time ahead of the specified expiry date. See also European-style option.



The cost of intangible asset acquisition spread across its lifetime. See also depreciation.


Animal spirits

Psychological traits and urge for action (or inaction), as motive for investment decisions, largely influenced by perception of the environment and by others’ thoughts and actions.


Annual equivalent rate (AER)

The interest rate received for the year on deposits and savings, taking into account the frequency as well as the number of payments.


Annual percentage rate (APR)

The interest rate charged for the year for borrowing money, taking into account the frequency as well as the number of payments.


Annuity rate

The amount of income payable per unit of lump sum invested in an annuity. Unlike most other investments, the lump sum is not returnable.



The pursuit of profit from price misalignment by buying the underpriced asset and/or selling the overpriced asset.



What a company or an individual owns, or can collect from others who owe them money.


Asymmetric information

One party in a transaction knowing more than the other. Sometimes the one who knows more can get a better deal; but if the other side knows this, they adjust prices to offset their risk, so that sharing the information can actually produce a better deal.


Balance sheet

A periodic record of the assets and liabilities of a bank or non-financial company, showing what it owns and what it owes.


Bank for International Settlements (BIS)

An international organisation that harmonises banking regulations and serves as a bank for central banks.


Bank run

A rush by depositors to withdraw their money from a bank because they think it is no longer safe.


Base rate

The official interest rate at which the central bank lends to other banks, which sets a baseline for the interest rates available to private borrowers and lenders. See also repo rate.


Basel II agreement

Internationally agreed rules setting minimum capital requirements for banks in relation to their risk-adjusted assets.


Basis point

One hundredth of a percentage point, used for exact specification of interest rate levels and changes.


Bear market

A market where the majority of investors are selling (‘bears’), causing overall share prices to fall. See also bull market.


Behavioural finance

An approach to investor behaviour that takes account of departures from ‘rational’ decision making under social, emotional or cognitive influences, and their impact on financial markets.


Bell curve

See normal curve.



A performance target: for active investors, the return on investment in the market portfolio.



The beta of a portfolio (or an individual share) measures the sensitivity of its return to changes in the return from the market portfolio.


Bid–ask spread

The difference between the bid price received by the seller of an asset and the slightly higher ask or offer price paid by the buyer.


Black Swan event

An unexpected event that has a major impact on the course of history, and can usually be rationalised only after it happens. See also high sigma event.


Black–Scholes formula (or model)

A formula (or model) of share option pricing, named after its inventors, Fischer Black and Myron Scholes. Based on the CAPM, it links the price of a call option to its strike price, the time to expiry, the spot-market price of the underlying asset, the risk-free rate of interest, and the volatility of the underlying asset.


Blue-chip shares

Shares in large, well-established companies that typically pay dividends and are expected to deliver growth in line with the general economy (named after the highest chip in poker).



Investments which that are loans to a government, company or other body. Typically, a bond has a set repayment date and, in the meantime, pays interest and can be bought and sold on the stock market.


Bounded rationality

The idea that individuals’ rationality is limited by the information that they have access to, available time and cognitive (brain power) limitations.


Bretton Woods Agreement

The 1944 agreement between major economies that tied monetary policies to a fixed exchange rate system, and created the International Monetary Fund and the World Bank, with the objective of securing global financial stability and faster economic growth.



An intermediary acting for a buyer or seller of securities who may receive a commission for arranging their purchase or sale.



The inflation of an asset price, eventually reversed by a sudden burst or a prolonged decline.


Building society

A mutually owned financial institution, originally set up to take deposits from members and give them loans with which to build or buy houses.


Bull market

A market where the majority of investors are buying (‘bulls’), causing overall share prices to rise. See also bear market.



A Paris Stock Exchange index of the largest 40 French companies, weighted by market capitalisation.


Call option

An option to buy an asset at or before a specified future time and price.



A resource that can be used to generate income, such as an investment in machinery that generates profit (physical capital) or skills that command a higher salary (human capital) or money utilised by an investor (financial capital).


Capital Asset Pricing Model (CAPM)

A financial theory which states that, under certain (restrictive) assumptions about investors’ preferences with risk–return opportunities, the discount rate used to calculate the net present value of a risky investment is the difference between the market return and the risk-free

rate. It implies that all investors should buy the market portfolio and combine it with the risk-free asset according to their attitude to risk.


Capital market line

A line representing combinations of the market portfolio and the risk-free asset. See also efficient frontier.


Capital ratio

The proportion of a bank’s assets, recorded on its balance sheet, that can reliably hold their value – as distinct from investments that could fall in value, or loans that could be diminished by a wave of defaults.


Capital risk

The possibility that investors may lose some or all of their original capital and returns (if reinvested) made to date.


Central bank

The bank that issues a nation’s currency, sets its interest rates, manages its foreign currency and supervises other banks. Examples are the Bank of England (UK), the Federal Reserve System (USA) and the European Central Bank (eurozone).



Use of past price patterns to predict an asset’s future price movements. See also technical analysis.



Turning over the investments in a portfolio, incurring transaction costs.


Classical economics

Economic theory based on the assumption that prices are fundamentally determined by input costs and will adjust (along with wages and interest rates) to keep the economy at full employment. See also neoclassical economics, supply-side model.


Collateralised debt obligations (CDOs)

Bonds secured against a bank’s loan books (of which mortgage-backed securities are one type).


Commercial bank

A bank that takes deposits from, and makes loans to, households and businesses, engaging in maturity transformation to offer longer-term loans. See also investment bank.


Complete information

The situation in which all market participants know all the information held by, and strategies available to, all other participants, and know that this information is shared. See also perfect information.


Compound interest

Interest earned not just on the amount originally invested but also on the interest previously earned and reinvested.


Confidence indicator

An index measuring optimism about future prospects of the economy and their own situation, among consumers, producers or investors; used to inform investment strategies and economic forecasts.


Consumer Prices Index (CPI)

The average price of a range of goods and services consumed by a typical household; the measure of inflation targeted by the Bank of England, and used for comparisons by international organisations such as the OECD and the EU. See also Retail Prices Index.


Contract for difference (CFD)

An arrangement where an investor expecting a price rise can ‘borrow’ a quantity of an asset, in the hope that the profits from the price rise will exceed the interest cost of the loan; or one expecting a price fall, who can ‘lend’ a quantity of the asset, receiving interest that they hope will outweigh the amount that they must pay out to compensate for the price fall.


Convertible unsecured loan stock (CULS)

Corporate bonds that can be converted to ordinary shares on set future dates at pre-set prices. As a conversion date gets closer, CULS tends to behave more like the underlying shares than like bonds.


Cooperative bank

A bank that operates comparable loan and savings-account facilities to a commercial bank but is owned by its depositors and borrowers, not by external shareholders.



The extent to which movements of variables are associated with each other.



Falling when the state of the economy improves, and vice versa. For example, governments’ fiscal deficits and insolvency practitioners’ revenues tend to vary countercyclically. See also cyclical.


Counterparty risk

The risk that the counterparty to a transaction or contract will default on their obligations.



The interest rate on a bond expressed as a percentage of nominal (par) value.


Credit crunch

A period when banks drastically reduce their lending to companies and individuals, in an attempt to restore their balance sheet and cash flows.


Credit default swap (CDS)

An arrangement whereby an investor ‘insures’ a risky loan through regular payments to a counterparty, which agrees to repay the loan if the borrower defaults.


Credit rating agency (CRA)

An organisation licensed by regulators and paid by government or corporate borrowers to issue default-risk assessments on their bonds.


Credit union

A financial institution originally set up to take deposits from members, offer them unsecured loans when their ability to repay was deemed adequate, and channel any profits into community improvement, including members’ financial education.


Currency risk

Where an investment is denominated in a foreign currency, the risk that unexpected changes in the exchange rate will alter the sterling (or other home currency) value.



Rising and falling with the state of the economy. Thus income and profits of a cyclical business will tend to be high at times of fast economic growth, and low or negative when the economy is stagnant or shrinking. See also countercyclical.


Default risk

The likelihood that a borrower will fail to repay a loan, or make other due payments, usually because of insolvency.


Defensive shares

Shares in companies with lower risk than their benchmark and more stable returns prospects though lower beta (beta less than 1). See also aggressive shares.


Defined benefit

A pension payout calculated in accordance with a pre-set formula rather than determined by investment returns and other factors.


Defined contribution

A pension payout determined by a private fund’s investment returns and other factors.



Falling prices, shown by a negative inflation rate.


Demand-side model

An economic model that views the price mechanism as insufficient for demand to absorb full-employment supply at all times, with periodic need for government intervention to boost demand upwards. See also supply-side model.



The conversion of a building society or other mutual financial institution into a bank, through the issuance of external shares, sometimes compensating depositors and borrowers with a bonus paid from reserves.


Department for Work and Pensions (DWP)

The UK government department responsible for welfare, social benefits, pensions and employment.


Dependency ratio

The ratio of non-working to working-age population. See also support ratio.


Deposit protection

A mechanism for reimbursing savers whose money is lost through the collapse of a financial institution; also termed deposit insurance, as usually funded by a levy on institutions. See also Financial Services Compensation Scheme.



The cost of tangible asset acquisition spread across its lifetime. See also amortisation.



A prolonged period of low economic activity and high unemployment that may not be reversible without government intervention. See also recession.



The loosening of rules of a particular market or industry.



A contract on one or more underlying assets, whose price is derived from the spot-market price of the assets.


Discount rate

The rate of return that will set a stream of future payments from an investment equal to its present value.



The process of reducing a future payment to find out how much it is worth today. See also present value.



Reducing risk by combining a variety of investments that are unlikely to all move in the same direction at the same time.


Dividend cover

Earnings per share divided by the net dividend per share.


Dividend payout ratio

The percentage of a company’s earnings (profits) for a given period paid

out to shareholders as dividends.


Dividend valuation model (DVM)

A method of trying to find the intrinsic value of an investment in shares by discounting an assumed flow of dividends that continues indefinitely; also known as dividend discount model.


Dividend yield

Net dividend per share divided by the current share price.


Dow Jones Industrial Average (DJIA)

The earliest US stock exchange price index, a price-weighted average of the largest 30 companies in the USA.


Dynamic tension

Continuous interplay between the potential for free markets to boost investment returns through innovation and efficiency gain, and the need for regulation to contain risks.


Efficient frontier

A curve representing the most efficient combinations of risk and expected return, portfolios on which are said to be Markowitz efficient. They include the market portfolio. See also capital market line, CAPM.


Efficient Markets Hypothesis (EMH)

The theory according to which financial markets present some degree of informational efficiency, so that prices reflect the best information available in the market.



The point at which price and quantity of the demand side meet those of the supply side, and are supposed to remain stable if conditions do not change.



Shares; also called stocks (in the USA).


Equity release

Withdrawing capital (as income and/or a lump sum) from a paid-for property, often by remortgaging.


Ethical investment

A strategy of focusing on investments that promote the social and natural environment (such as affordable housing and renewable energy), and avoiding those viewed as damaging it (such as tobacco and rainforest logging).



Principles for determining appropriate conduct and values in social or commercial situations.



An alliance of the Paris, Brussels and Amsterdam stock exchanges.


European-style option

A share option that can be exercised only on a specified expiry date. See also American-style option.



A geographic area that comprises all countries in which the euro has been approved as the official currency by the European Central Bank.


Excess volatility

The degree to which share prices are more volatile than the underlying earnings (or other fundamentals).


Excessive discounting

Putting too much weight on present income or value, by discounting future income flows at too high a rate.


Exchange rate

The number of units of a foreign currency that exchange for one unit of home currency (or vice versa).


Exchange rate swap

An arrangement whereby a company (or investor) that wants funds in one currency but can borrow more cheaply in another (usually that of its home country) swaps currencies with another that can borrow more cheaply in the target currency.


Exchange-traded fund (ETF)

A funds that typically tracks market indices.


Expected value or return

The average of possible returns from an investment, where each possibility has been weighted by the probability that it will occur.



A situation in which social costs are greater than private costs, or social benefits greater than private benefits.


Fat tail

A distribution of data (such as possible investment returns) where even values that are a long way from the expected value have a relatively high probability of occurring. See also Black Swan event, high sigma event.


Federal Reserve

The US central bank (equivalent to the Bank of England).


Financial exclusion

The inability to access mainstream financialservices, and employment and market opportunitieslinked to these. Factorscontributing toexclusion may includelow income, location,adverse history andinappropriate products.


Financial Ombudsman Service (FOS)

The official independent body appointed to settle consumer complaints against financial services providers.


Financial regulation

The imposition of rules on financial transaction, accounting and investment behaviour, by government or other agencies, designed to uphold professional ethics and prevent systemic and prudential risks. See also professional regulation, systemic regulation.


Financial Services Authority (FSA)

The UK financial services regulator from 1997.


Financial Services Compensation Scheme (FSCS)

A fund set up to insure UK personal investors against loss if a financial firm fails owing them money. It covers investments, bank (and similar) deposits, mortgages and insurance.


Fiscal deficit

The excess of government spending over the revenue that it receives, usually expressed as a proportion of national income.


Fiscal policy

Decisions by government on public expenditure and taxation.



One of the major three credit rating agencies.


Fixed capital

Machinery, buildings, communication and transport networks, and other physical installations that sustain many runs of a production process.


Footsie (FTSE) All Share Index

A London Stock Exchange weighted index of the largest market capitalisations of UK companies; in 2009, included 619 shares, weighted by market value, which represent 98–99 per cent of the value of all the shares listed on the market.


Footsie 100 Index (FTSE100)

A London Stock Exchange weighted index of the largest 100 market capitalisations of UK companies.


Forward market

A market in which the price and quantity of a transaction can be specified in advance, as through a futures contract or option contract. See also spot market.


Free markets

Markets where consumers and producers exchange goods and services at mutually agreed prices, without the intervention of a central coordinating authority.


Friendly society

A mutual insurance association formed to encourage saving for old age, sickness, burial expenses or nest eggs for children.


Fundamental analysis

A method of trying to find the intrinsic value of an investment by examining factors that may affect it, including the financial and operating situation of the provider, sector conditions, investment markets and the wider economy.


Futures contract

A contractual right to buy or sell a quantity of an asset at a specified price at or before a future date.



‘Gilt-edged’ bonds, issued by the UK government.


Glass–Steagall Act

Act passed in the US on 13 June 1933 to formally split commercial banking from investment banking institutions; repealed in 1999.


Great Depression

Massive shrinking of the world economy which followed the Wall Street and other stock market crashes in October 1929. The Depression lasted until 1933 in many western countries.


Gross Domestic Product (GDP)

The value of all the goods and services produced by a country over a year.


Growth fund

An investment fund targeting capital appreciation by selecting companies tipped for above-average earnings growth and reinvesting dividends. See also income fund, value fund.



To invest in a way that protects income or wealth against unpredictable price movements.


Hedge fund

A fund that engages in a wide range of investments, usually pursuing absolute returns, and may (but does not necessarily) hedge its risks.


Herd behaviour

Behaviour that is influenced by what others think or do, sometimes away from what an individual would do if acting rationally.


High sigma event

An event that, if normally distributed, should be very unlikely, as shown by its large standard deviation (sigma) from the mean. See also Black Swan event, fat tail.


HM Revenue & Customs (HMRC)

The UK government department responsible for taxation.


HM Treasury

The UK government department responsible for overseeing financial regulation and fiscal policy.


Human capital

Capacity, based on qualifications, skills and experience, to produce income through working.



Very high inflation.



The inability to meet immediate cash demands, including short-term debt repayments, due to unavoidable delays in receiving income or selling off assets even if there is still fundamental solvency.


Imputed rent

The financial benefit that a homeowner is deemed to receive as a result of not paying rent.


Income fund

An investment fund that favours companies with high dividend yields. See also value fund, growth fund.


Income risk

The risk, where payments are variable, that they may fall below the amount the investor had expected, or fail to be paid.


Income statement

An annual accounting report that shows how a bank or non-financial company has made (or lost) money in the past financial year.


Index fund

An index fund is a fund that aims to track rather than outperform a particular stock market index.


Index-linked gilt

A UK government bond whose interest payments and redemption value are increased in line with inflation throughout the life of the bond.


Individual Savings Account (ISA)

A tax wrapper for savings and other investments, subject to maximum annual allowances.



A rise in the general level of prices that means that over time a constant sum of money will buy less and less. The rate of inflation is the annual percentage change in the price of a large basket of goods and services that are typical of the way households spend their money. See also CPI and RPI.


Inflation risk

The risk that the return from an investment will be worth less than expected in real terms because of an unexpected rise in prices.



An intermediary who provides information, analysis or forecasts on financial variables of interest (share prices, companies’ profits, etc.).


Information cascade

The process of people ignoring their own private information and basing a decision on what others have decided to do (e.g. invest in certain stocks). It can lead to herd behaviour.


Information ratio

A risk-adjusted performance measure of fund performance: the alpha divided by the tracking error. It identifies funds that earn consistent, positive alphas, rather than higher but more volatile alphas over time, so is a widely used measure of active fund managers’ success.


Informational efficiency

When prices reflect the best information available in the market. See also perfect information, complete information.


Initial public offering (IPO)

The flotation of new shares on a stock exchange, when a formerly privately-owned company ‘goes public’.



The situation of being unable to repay all debts, owing to liabilities exceeding the sum of assets and shareholders’ equity.


Institutional investor

A financial institution that invests large sums of money on behalf of others.


Inter-bank interest rate



Interest yield

The income that a bond will produce expressed as a percentage of the current market price.


Interest-rate risk

The risk that return on an investment differs from expectation because of unanticipated change in interest rates.


Interest-rate swap

An arrangement whereby two parties borrow on different terms, often one at a fixed rate and one at a variable rate, and then arrange payments of interest to each other.



A financial institution that connects buyers and sellers, or borrowers and lenders.


Intrinsic value

The fundamental, underlying or actual value of an investment as opposed to its market price, which may be out of line with its underlying value.



Deploying money with the aim of receiving more money, through income or capital appreciation, usually after a period of time and with an element of risk. In general, investing puts the initial (principal) sum at risk, whereas saving involves risk only to the income earned from the principal, but in practice the terms are often used interchangeably.


Investment bank

A bank that lends to businesses and governments for fixed investment (for example, in new machinery and infrastructure), and trades for profit in financial markets on its own account. It mostly raises capital from individuals or companies that are willing to invest it for a long period, via shares or bonds, rather than through customer deposits. See also commercial bank.


Investment fund

A financial product that invests in a broad range of different bonds, shares and/or other assets.


Investment grade

The highest grade assigned to borrowers and their bonds by a credit rating agency, signalling low probability of default.


Investment trust

A company that invests in a diversified portfolio of shares and/or other investments. Investors buy shares in the investment trust.



Assets that are traded on a stock exchange, or products that invest in such assets. More broadly, any item purchased with the intention of generating future financial income and/or growth and eventually recovering the original sum.



Usually describes a policy of pumping money into the economy, in particular by boosting government spending; derives from John Maynard Keynes, who showed that economies could operate with permanently high levels of unemployment. See also demand-side model.

Leading indicator

A measure of economic activity that tends to change before other measures change.


Lender of last resort

A central bank function under which it lends to banks that are in difficulty and unable to borrow from elsewhere.



Technically, the ratio of a company’s debt to its total capital (which also includes, for example, money raised through issuing shares). More generally, it means using borrowed funds to increase the return from an investment (whether made by a business or an investor).



What a company or an individual owes to others, and has to pay back to them.



A government policy to promote free markets and competition.


Liquid assets ratio

The ratio of cash and immediately cashable assets to total assets. Shows the proportion of what is owed – to creditors and shareholders – that could be paid back today, or in the next few days, from assets with high liquidity.



In accountancy, the ability of a business to pay its debts as they fall due.


Liquidity risk

The risk of being unable to cash in an investment rapidly enough, or for a sufficiently high price, to pay debts as they fall due or to take advantage of better investment opportunities.


Liquidity trap

A situation where low or even zero interest rates fail to revive an economy, because investors refuse to buy non-liquid assets. See also Keynesian.


Logarithmic scale

A scale used for plotting graphs where the values on an axis reflect ratios of the underlying quantity, such as a percentage increase.


London Inter-bank Offered Rate (LIBOR)

The rate of interest that sets the cost of borrowing funds (or making deposits) on the inter-bank market in the UK.


London Stock Exchange

The main London stock market, located in the City of London.



The tendency of individuals to dislike losses more than they favour equivalent gains. Leads to agents being risk-averse when faced with gains and risk-preferring when faced with losses.



The analysis of whole-economy features such as national output, inflation rates, interest rates and growth rates.


Margin trade

A short-term investment made with a loan, intended to be repaid from profits on price movement. A drop in the value of assets held relative to the amount borrowed may result in a ‘margin call’ for additional capital to close this gap.


Market capitalisation

A company’s current market value, obtained by multiplying its number of issued shares by their current market price.


Market portfolio

A portfolio of all the shares in the market, in proportion to their market value. Bought by investors or funds that wish to diversify away all specific risk; the portfolio recommended for all investors by the CAPM.


Market return

The return on the market portfolio. See also beta.


Market risk

The risk on the market portfolio, arising from events that unexpectedly affect asset prices throughout the market and not from those that affect the prices of specific assets.


Market timing

An investment strategy that involves buying and selling a particular portfolio to try to outperform the alternative strategy of buying the portfolio and holding it.



An individual or firm that buys and sells assets in large amounts, ensuring a liquid market in them.


Markowitz diversification

Combining portfolio assets in an effort to lower risk without sacrificing expected return.


Markowitz efficient

Describes a portfolio that has the highest expected return for a given level of risk.



To put a value on an investment, for balance-sheet purposes, by taking its current market value.


Maturity transformation

Turning short-term, highly liquid liabilities (such as households’ bank deposits) into longer-term, less liquid assets (such as loans to companies for fixed capital investment).



The weighted average of a set of values. Provided all values are equally probable, it is obtained by adding them up and dividing the total by the number of values.



The analysis of an economy’s constituent parts, e.g. firms, consumers and particular markets, and especially the role of prices and wages as incentives for efficiency.



Inducing personal investors to buy a financial product that is unsuited to their needs and circumstances, and/or that involves them in financial loss, usually after failure to follow an acceptable sales procedure.


Momentum trading

Buying assets whose prices are moving, in order to profit from further movement; sometimes termed ‘noise trading’ because it focuses on (and may amplify) unexplained price movements that other traders call noise.


Monetary policy

The control by central banks of money supply and interest rates.


Money market

A market for overnight and very-short-term loans to governments and large companies, in which investments are regarded as highly liquid and low-risk.


Money market fund

An investment fund that seeks low-risk returns predominantly in the money markets.


Money multiplier

The ratio of banks’ deposits to banks’ reserves; used in a model that suggests that banks, by channelling deposits/savings into investments, inject money into the economy.



One of the major three credit rating agencies.


Moral hazard

The risk that insuring or otherwise protecting someone against a bad outcome will make them less careful about the consequences of their actions and so encourage more risky behaviour.



A long-term loan used to buy a fixed asset (such as a house), and secured against the asset.


Mortgage bank

A commercial bank specialising in mortgage loans to households.


Mortgage-backed securities (MBSs)

Bonds secured against a bank’s loan books; a form of securitisation used by commercial banks and building societies to raise capital.


MSCI World Index

The Morgan Stanley Capital International composite index of all major indices of 23 developed countries, weighted by market value.


Naïve diversification

When shares are combined without reference to their risk–return characteristics in an effort to lower portfolio risk. See also Markowitz diversification.



The National Association of Securities Dealers’ Automated Quotation, an over-the-counter US securities market, specialising in high-technology companies.


National income

The sum of all the income spent in the economy (consumption by households, investment by firms, net government expenditures, and current balance of payments), a close equivalent to the Gross Domestic Product, and functionally equivalent to national output and national expenditure.


Negative equity

The excess of a mortgage over the value of the property that it is secured against.


Neoclassical economics

A development of classical economics that recognises some demand-side problems but still traces them to price and wage inflexibility, and assumes that decisions are taken as if individuals have full information that they process rationally.



Favouring reduction of taxes and state provision wherever private provision can be argued to be a viable alternative.



Usually ‘after tax’, in contrast to the gross (pre-tax) amount. Can also mean ‘after depreciation’ (as with net national product), ‘after deduction of interest’ (as with net profit) or ‘after deduction of liabilities’ (as with net asset value).


Net asset value (NAV)

The market value of the portfolio underlying a unit trust or investment trust. The net asset value per share is the net asset value divided by the number of shares or units.


New Deal

A massive programme of government spending (mainly in public infrastructure) launched by US President Roosevelt to combat the Great Depression of the 1930s.


New York Stock Exchange (NYSE)

The New York stock market. Also known as Wall Street, where it is located; owner of Euronext.



The terrorist attacks on New York’s World Trade Center and other US locations on 11 September 2001, which aroused fears of systemic risk and were viewed by many as signalling a new age of financial and geopolitical uncertainty.


Noise trading

See momentum trading.


Nominal value

A cash value that takes no account of the buying power of the units in which it is expressed. Also the cash sum repaid on redemption of a conventional bond held to maturity. See also real value.


Normal curve

A graph that shows the probability of an outcome taking on different values and which has some specific characteristics: the possible outcomes are distributed symmetrically around the expected value (mean); a known proportion of the outcomes lies within a specified distance of the expected value. Also known as a normal distribution or bell curve.


Occupational pension

A pension scheme offered by an employer (which must contribute at least part of the cost). See also state pension.



The organisation for Economic Co-operation and Development, which promotes policy cooperation and data-sharing among the world’s higher income nations.


Office of Fair Trading (OFT)

The UK government department responsible for consumer protection.



The UK Office for National Statistics.


Open-ended investment company (OEIC)

An investment fund structured as a limited company (like an investment trust) but enabling investors to purchase shares in specified types of portfolio.


Operating costs

Wages, raw materials and other items that go into creating and delivering a company’s goods and services.


Option contract

An optional futures contract. See also put option, call option.


Ordinary shares

Shares whose dividends are not guaranteed to be paid and may vary in amount. Ordinary shareholders are given votes with which they can try to influence the running of the company; if it fails, they can recover capital only if there is some left after assets are sold to pay off the company’s debts.



A strategy by which a bank securitises and sells its customer loans, instead of retaining them for a long-term relationship with the borrower. See also structured investment vehicle.


Over-the-counter (OTC)

Trade in a non-standardised contract, away from a stock exchange or other organised exchange.



Moving too frequently between one share or fund and another. See also churn.



A situation where an asset’s market price exceeds the present value of its expected payment stream.


Passive investor

An investor who seeks to track, and not outperform, a specified investment benchmark.


Pay-as-you-go (PAYG)

A system of financing state (and sometimes other) pensions through taxation, so that today’s retirees are financed by today’s taxpayers; often contrasted with ‘funded’ pension schemes, which finance retirement by drawing down an individual’s savings and investments made while they were working.


Peer group

A group of funds with the same investment objectives.


Perfect competition

The existence of many buyers and sellers in a market, none of which can affect the market price.


Perfect foresight

The accurate prediction of future values: often assumed in economic models featuring rational agents.


Perfect information

The situation where all market participants know prices and quantities of all transactions that other agents have entered into. See also complete information.


Personal pension

A pension scheme to which individuals can contribute and which is not linked to any employment; treated for tax in the same way as an occupational pension, but usually the employer does not contribute. See also SIPP.



A set of financial assets held by an individual, bank or other financial institution.


Portfolio theory

An approach that determines the risk and return of a portfolio given the risk, return and correlation of its assets.


Positive feedback

A process through which a shock to a system generates further movement in the same direction; also called ‘cumulative causation’ or ‘reinforcement mechanism’.


Prediction market

A market created to predict outcomes of an event, by inviting people to place bets on it.


Preference shares

Shares that offer a fixed-rate dividend provided that the company’s profits are sufficient to cover it. Preference shareholders are paid ahead of ordinary shareholders, and if the company is wound up, they have priority entitlement to any liquidated assets.


Present value

The value today of one or more payments due to be received in the future; obtained by applying a discount rate to the future payments, to reflect the fact that money in future is generally worth less than money today.


Price mechanism

The adjustment of prices, upwards when there’s a shortage and downwards when there’s a surplus, so that market supply and demand move into balance.


Price–earnings (P/E) ratio

The ratio of the share price divided to the company’s yearly earnings per share. An approximate indication of the years that it would take to recoup the price paid for the shares, mainly used as a measure of their (and the company’s) relative value.


Private equity

An equity investment by individuals or institutions that is not publicly traded; the investment is exited by privately selling the stake, or floating the company through an initial public offering. See also venture capital.


Private pension

Any non-state pension scheme, i.e. an occupational or personal pension.


Professional regulation

Rules that professionals (including bankers and financial advisers) impose on themselves, directly or through a professional institution, to ensure principled and financially sustainable behaviour. See also ethics, financial regulation.


Prospect theory

A financial theory that argues that individuals’ preferences under uncertainty are influenced differently when faced with losses or with gains, and by the framing of the choices available; see loss-aversion.


Prudential risk

The risk of a financial institution encountering financial difficulty, including insolvency or illiquidity, due to inadequate internal financial control.


Public company

A company that has issued shares to the general public (‘gone public’), the shares being listed and re-traded on a stock exchange.


Put option

An option to sell an asset at or before a specified future time and price.


Random walk

A journey in which the direction of the next step is not influenced by the direction of the previous step; characterises the path of share prices, according to the efficient markets hypothesis.



One amount shown in proportion to another; can be expressed as a percentage or a fraction.



In economics, the pursuit by individuals or organisations of goals in the most efficient way possible, usually by maximising financial or material gain subject to constraints of income or wealth. For example, businesses are assumed to maximise profits, and rational investors are assumed to maximise subjective well-being (linked to wealth), given the resources that they have available to invest.


Real economy

The production and trade of goods and services, as opposed to trade in investment products and money (the financial economy).


Real value

The value or price of something after stripping out any change due to inflation. For example, if £100 is invested and grows to £110 but the general level of prices goes up 10 per cent, the real value of the investment is still only £100.



An economic downturn, technically defined as two or more successive quarters of declining national output (or ‘negative growth’). See also depression, Keynesian.


Redemption yield

The total return that a bond will produce expressed as a percentage of the current market price, assuming that the bond is held until redemption. It takes into account both the interest and the redemption value.


Relative return

Investment performance expressed in comparison with the investor’s peer group, or a benchmark such as the market return. See also absolute return.


Repo rate

The interest rate at which a central bank makes short-term loans to commercial banks (sometimes called the ‘official rate’ or ‘policy rate’).


Retail Prices Index (RPI)

The inflation measure that uses a slightly different range of goods and services from the CPI, mainly through including housing costs. Used in the UK to adjust state benefits, pensions and interest on index-linked gilts and other index-linked investments.


Return on assets (ROA)

Net income as a percentage of total assets.


Return on equity (ROE)

Net income as a percentage of shareholders’ equity; can be raised above return on income or assets if these have been expanded beyond equity through the use of leverage.


Return on investment (ROI)

Net discounted income from an investment expressed as a percentage of the initial amount invested.



The element of uncertainty over an investment’s future price or return that can be numerically estimated, through its variability or volatility.


Risk premium

The extra return that an investor expects as a reward for choosing a risky investment rather than a risk-free one.



Tending to choose an investment with a lower level of risk than another comparable investment. See also risk-preferring.


Risk-free asset

A security whose return must comprise one or more fixed payments on one or more set future dates with no possibility of a different outcome. In the real world, there is no completely risk-free investment, but shortterm bonds issued by the governments of large, high-income economies such as the USA and the UK are regarded as almost risk-free.



Tending to choose an investment that offers a higher level of risk than another comparable investment; the opposite of risk-averse, also known as risk-seeking.


Risk–return spectrum

The relationship between the risk of, and return from, investments: usually, lower-risk investments offer lower returns, while investments offering the chance of higher returns involve additional risk.


R-squared (R2)

The percentage of the total risk of a portfolio that can be explained by market risk. The remainder is the percentage represented by specific risk.



Standard & Poor’s weighted index of the largest 500 market capitalisations of US companies on the NYSE or NASDAQ.



Looking for a satisfactory, sufficient solution rather than the most efficient (maximising or optimising) one. See also rationality.



The flow of money not used for current consumption and which contributes towards an individual’s or household’s savings.



The total value of all financial assets, including investments, that an individual or household has at a particular point in time.


Savings bank

A bank that takes deposits from ordinary households, offering them interest, which is financed mostly by lending to the government, local authorities or other very safe borrowers.


Say’s Law

The idea that supply creates its own demand. See also supply-side model.



Also called equities, securities or stocks. These are investments where each holder becomes part-owner of a company. The return may comprise regular dividends (a share of the company’s profits) that are not guaranteed and/or a capital gain or loss when the shares are sold. Shares are often, but not always, traded on the stock market.



Groups of companies listed on a particular stock exchange that carry out the same activity (e.g. electrical engineering, property construction or financial services).


Securities and Exchange Commission (SEC)

The US authority that supervises stock exchanges and other financial services providers.



Turning an asset that produces a regular flow of income (such as a bundle of bank loans, or properties generating rents) into a tradable investment such as a bond that can be sold to other banks and nonbank investors.



A tradable financial investment such as a share, bond or futures contract.


Self-invested Personal Pension (SIPP)

A personal pension that allows individuals to manage their own investments, giving access to a wide range of investments within the pension tax wrapper.


Shareholders’ equity

Capital subscribed by shareholders, which gives public companies a buffer between assets and liabilities.



Investments that give the holder a share in ownership of a company. They generate a return through dividends (though these are not guaranteed even if the company makes profits) and/or a capital gain or loss when the shares are sold. Shares in public companies can be traded on a stock market. Also called equities or stocks.


Sharpe ratio

An investment fund’s return per unit of total risk: obtained through dividing its ‘excess’ return (the expected return relative to the risk-free rate) by its risk, the standard deviation of returns.


Shortfall risk

The risk that a predefined savings or investment target will not be met.



Borrowing and selling an asset on the expectation that it will fall in price before the loan is repaid.



A situation where the data (such as possible investment returns) are not distributed symmetrically around the expected value. See also normal curve.


Small print

A product’s terms and conditions, typically written in small letters and/or technical jargon.


Social costs

Costs arising from production or consumption that are not paid by the individual or institution concerned, but imposed on the rest of society; e.g. the pollution emitted by a car or factory. See also externality.



The ability to repay all debts and remain financially viable, usually indicated by assets exceeding liabilities on the balance sheet.


Specific risk

The risk specific to a company, which can be reduced through diversification.


Speculative grade

A low grade assigned to a borrower and its bonds by a credit rating agency, indicating a relatively high default risk, thus usually commanding higher interest rates (due to the risk premium) compared with investment grade bonds.


Spot market

A market in which transactions are agreed for immediate exchange and settlement. See also forward market.


Spread betting

An arrangement whereby an investor can place bets on an asset price or index moving above the offer price or below the bid price set by a spread betting firm.



A combination of inflation and economic stagnation or negative growth, usually with high unemployment.


Stamp duty

Tax payable on the purchase of a share or property (as a proportion of its value at purchase). Not due on share sales.


Standard and Poor’s (S&P)

One of the three major credit rating agencies; US financial publisher that also provides share-price indices such as the S&P500.


Standard deviation

A measure of the extent to which outcomes spread out to either side of the mean. Commonly used in investment as a measure of risk. See also variance.


State pension

A pension paid by a government to people who have reached a specified age and meet specified contribution conditions, funded by taxation.


Stock exchange

An organised market on which shares and bonds are traded.


Stock selection

An investment strategy that involves buying shares in different proportions to their weighting in a stock-market index to try to outperform that index, especially by ‘overweighting’ undervalued stocks and ‘underweighting’ overvalued stocks.


Structural change

A change in the social, economic, political or technological conditions shaping economic activity; usually slower but less predictable or reversible than cyclical change.


Structured investment vehicle (SIV)

An off-balance-sheet subsidiary sometimes established by financial or non-financial companies to buy assets, especially securitisations, from the company. Also known as special-purpose vehicle; disappeared after the banking crisis that began in 2007.


Structured product

An investment product that guarantees the investor either a minimum capital amount at the end of the product life or a minimum income over the product life, and uses derivatives or other complex strategies to deliver the promised amounts.


Supply-side model

An economic model that argues that supply of goods and services creates its own demand, mainly through price adjustments. See also Say’s Law.


Support ratio

The number of people of working age divided by the number of people over state pension age. See also dependency ratio.



A kind of financial derivative whereby two investors holding different assets agree to exchange the income streams that they generate.


Systematic risk

A market risk that cannot be reduced through diversification.


Systemic regulation

Regulation to avoid a threat to the whole economic system.


Systemic risk

The danger that problems in one financial institution will spread through the whole system, due to the way in which institutions are financially interconnected. Because of its huge scale and unpredictability, it is not a risk that can be insured against without government help.

Tax wrapper

An administrative structure that shields an investment from either some or all tax.


Tax year

The 12-month period across which, for example, investment and other income is assessed for tax; in the UK this begins on 6 April and ends on 5 April of the next calendar year.


Technical analysis

Use of regularities or trends in past price data to predict future prices. Closely related to chartism.


Time diversification

The practice of investing and/or cashing in investments in a series of lump sums spread over time, in order to remove the risk of choosing a bad time to invest (when prices are high) or disinvest (when prices are low).


Time preference

The tendency of people to prefer ‘present goods and services’ (those available for consumption now) to ‘future goods and services’ (those expected to be available for consumption at a future date). See also discounting, excessive discounting.


Tobin’s q

The value that the stock market puts on a company (measured as the market value of its shares and debts) divided by the cost of replacing all the firm’s assets. A value less than 1 suggests that the company is undervalued.


Total expense ratio

The annual cost to a client of an investment fund, including all management fees and charges, but excluding dealing costs.


Tracking error

The volatility or standard deviation of an investment fund’s alpha over time. The larger the tracking error, the more likely is a high outperformance or underperformance in any one period.


Transaction cost

The costs incurred when buying or selling an asset, or taking out or closing an investment.


Transfer payment

A tax-funded welfare benefit, such as a state pension or jobseeker’s allowance.


Treasury Inflation-protected Securities (TIPs)

US government bonds where the interest payments and redemption value are increased in line with inflation throughout the life of the bond.



A situation in which the probability of an event cannot be estimated. See also risk.



A situation in which a share price is below the present value of its fundamentals.


Unit trust

A trust that holds shares on behalf of investors. Investors hold units in the unit trust.


Value fund

An investment fund that focuses on stocks believed to be undervalued, seeking investment returns through capital gain, when undervaluation is corrected, as well as dividends. See also growth fund, income fund.


Value share

A share believed to be undervalued because most investors have ignored or failed to understand the company.



A measure of the dispersion of a set of values, calculated as the sum of their squared deviations from the mean, i.e. the square of the standard deviation.


Venture capital

A form of finance used to fund start-up companies; as these are typically riskier than mature companies, and capital cannot usually be retrieved unless the enterprise is later sold to another company or shareholders, venture capital investors expect high average returns.



The variability of share prices, investment, or any other series of values around their average, usually measured by their standard deviation or variance.



Securities, re-tradable on a stock exchange, that give the buyer the right to purchase the company’s shares on one or more set future dates at preset prices. Typically issued to buyers of newly issued shares to make them more attractive. Comparable to a call option on the shares.


Weighted average

An average that allows for the relative importance of each component.


Welfare state

A system whereby the government funds or provides public services and redistributes income to provide a ‘safety net’ for its citizens. See also transfer payment.


Working capital

Raw materials, unsold stocks, and other expenditures on production from which money is recovered at the end of the production process when goods or services are sold.


Year-to-date period

The period starting on 1 January of the current year and ending on the current date.