Investments term explained

|    Standard Chartered Bank    |

FOR new investors, it is useful to understand some investment terms used.

Asset allocation

The distribution of different parts of a portfolio to different types of investment in order to minimise risk.

Cash and equivalents

The value of assets that can be converted into cash immediately, as reported by a company.

Usually includes bank accounts and marketable securities, such as government bonds and Bankers’ Acceptances. Cash equivalents on balance sheets include securities (eg notes) that mature within ninety days.

Bond fund

This is a fund that specialises in pooling the purchases of bonds into a diversified portfolio. The value of the bond fund is based on the market value of the bonds in the portfolio.

However, unlike a regular individual bond, the fund will not actually mature.

Therefore, an investor will not get his principal (par value) back at any particular date; the value of the principal amount will always vary depending on the current NAV of the fund.

Bond rating

A bond rating demonstrates the creditworthiness of a bond issuer as determined by one of several rating services: Moody’s Investors Service, Standard and Poor’s and Fitch Investor’s Service.

They evaluate bond issuers’ financial strength and cash flow with respect to projected interest payments and principal repayment. Ratings range from AAA (highest) to D (in default).

Bonds rated below BBB are not investment grade and are termed “junk bonds” in the trade.

Diversification

Diversification involves splitting your money up so that it can be invested in several different investment products to spread the risk so that the risk of loss is reduced. It means not putting all your eggs in one basket.

Unit trusts are one method of diversification because their portfolios consist of a variety of securities. For example, there’s more diversification in a stock and bond portfolio than in a portfolio constructed entirely of stocks alone.

Equity fund

An equity fund is a fund that invests in a broad portfolio of shares.

Expected return

The term is commonly used to refer to the expected or average rate of return on an investment. The investment’s expected return is simply the mean or expected value of the same distribution. The investment’s return volatility is the standard deviation of the same distribution.

Inflation risk

This is the uncertainty of the future real value of an investment.

Liquidity

This is the degree to which an investment may be quickly sold in exchange for cash. Unit trusts are a liquid investment; at any time, shares may be redeemed.

However, a property investment is not liquid. It cannot be easily sold and the settlement period tends to be as long as three months or more.

Liquidity risk

Liquidity risk is the risk by an investor of not being able to sell his/her investment due to thin trading volume. As a result, the investor may have to sell below the fair value if cash is needed urgently.

Long-run or long-term

A period of time in which short-term volatility or risk of the market does not play a significant role. Long-term is generally considered as a time period of ten years or more.

Risk

The chance that an original investment might lose value.

Risk tolerance

The willingness of an investor to tolerate the risk of losing money for the potential to make money.

Rule of 72

The rule of 72 is a simple estimate of how long it’ll take an investment to double with a given interest rate. For example, if you had an investment that you know will produce a 10 per cent return each year. Divide 72 by 10 (=7.2) and know it will take just over seven years for your investment to double.

Systematic risk

This is the risk where a localised problem in the financial markets could cause a chain of events that could ultimately cripple the markets.

For example, a default by a major market participant might cause liquidity problems for a number of that institution’s financiers.

This might cause those financiers to fail to make payment on their own obligations, and a liquidity crisis could spread throughout the markets.

One of the purposes of financial regulation is to ensure that the markets operate in a manner that minimises systematic risk.

Unit trusts

A Unit Trust is basically a big pool of money that many people contribute to.

The pool of money is invested by professional fund managers in stocks, bonds and other investment instruments. A trustee will be appointed to safeguard the interests of unit holders.

By contributing to this pool of money (buying “units” of unit trust), you’ll be given a little piece of the total portfolio (ie you OWN a part of the unit trust).

Volatility

This is the degree to which a pricing of an investment product will change in value. Volatility can simply be described as ‘riskiness’.

This article is for general information purposes only and while the information in it is believed to be reliable, it has not been independently verified by us. You are advised to exercise your own independent judgement with the contents in this article.