Annuity

An annual sum paid in perpetuity, usually for a fixed amount, although it can be linked to an index.

Annual report

All companies whose owners have a limited liability to the financial obligations of their company must publish an annual report, which is sent to the owners and lodged with a central authority for public inspection. For companies whose shares are listed on a recognised stock exchange, the annual report will almost certainly contain a mix of statutory information and information given voluntarily by the management. The statutory information includes a profit and loss account (income statement in the United States), balance sheet (statement of financial position in the United States) and cash flow statement, together with explanatory notes to these.

Amortization

US terminology for depreciation. In the UK amortization generally refers to writing off the cost of intangible assets.

American Stock Exchange (Amex)

New York's other stock market, the American Stock Exchange Stock Exchange (Amex) is similar to the much bigger New York Stock Exchange (NYSE) in its organisation and trading arrangements. However, Amex's presence in the equity markets has been squeezed by both the NYSE and NASDAQ. Indeed, it was taken over by NASDAQ in 1998, although it continues to run independently. Its origins date back to street trading in the late 19th century, and it was not until 1921 that it moved to a permanent building in Trinity Place in New York's financial district, where it is still based. By the mid-1960s the volume of stocks traded on Amex reached half the level of business done on the NYSE. Since then its relative importance has declined, so that at the end of 2002 the aggregate market value of domestic companies whose shares were listed on Amex was below $100 billion, compared with over $9,000 billion for the NYSE. However, Amex has been successful in derivatives trading, especially in exchange traded funds, which it launched in 1993 and whose trading it dominates, with US market share of over 90%.

Arithmetic mean

The full term for what non-mathematicians intuitively call the average and which is generally shortened simply to the mean. It is calculated by taking the sum of a series of values and dividing that number by the number of values. So if 12 values add up to 96, the average is eight. It should not be confused with the geometric mean, under which heading there is a fuller discussion of the circumstances in which it is more appropriate to use one or the other.

American depositary receipt(ADRS)

Most US investors who own shares in foreign corporations do so via American depositary receipts (ADRS). There is nothing to stop them buying overseas shares directly (although they may technically infringe the 1933 Securities Act when they come to sell them). ADRS, however, are much more convenient. Basically, they are tradable receipts which say that the underlying shares represented by the ADRS are held on deposit by a bank in the corporation's home country. The depository bank collects dividends, pays local taxes and distributes them converted into dollars. Additionally, holders of ADRS usually have all the rights of shareholders who own their stock directly. The vast majority of overseas corporations that list their shares on a US exchange use ADRS; at the end of 2002 there were over 1,000 such listings. ADRS have spawned imitators and nowadays there are global depositary receipts, basically ADRS which are traded on over-the counter markets in both the United States and the euro market, and European depositary receipts, which are traded on European exchanges.

Alternative investment market (AIM)

The London stock market's junior market for small, fast-growing companies, launched in June 1995. Its progress to date has substantially exceeded expectations and at the end of November 2002, 698 companies were quoted on the Alternative Investment Market (AIM) with a combined stock market value of £15.2 billion. The logic behind the AIM was to form a market with a minimum of regulation and spiced with tax breaks, thus creating a cheap means of raising risk capital for young companies. Since its launch, over 1,100 companies have had their shares listed on the AIM, raising over £12 billion in the process. Regulation is carried out by approved advisers rather than the exchange itself; and the information that companies have to supply is minimal as is the number of shares that have to be made available for trading.

Alpha

A term borrowed from statistics which is used to show how much of the investment performance of a stock or portfolio of stocks is independent of the stock market in which they trade.

• Within a simplified pricing model used to identify those portfolios of investments that deliver the best combination of risk and return, alpha is used to describe the expected return from a security or a portfolio assuming that the return from the market is zero. Thus in this model the expected return for, say, an ordinary share would be its alpha plus the market return leveraged by the share's sensitivity to market returns (its beta). Here both alpha and beta are estimated based on comparison of the historical returns of the share and the market (see also single index model).

• In measuring portfolio performance, alpha is used to define to what extent a portfolio has done better or worse than it should have done, given the amount of risk it held. If it is accepted that a portfolio's performance will (simply speaking) depend on market returns times the portfolio's sensitivity to the market, then alpha quantifies the extent to which the portfolio's return varies from its expected return. Thus it measures the extent to which the manager adds or erodes value.

Advance decline line

Also known as the breadth of market indicator, this plots the number of share prices that rise minus the number of share prices that fall over a specific period (usually a day or a week) for a given stock market average (the S&P 500 INDEX, for example). Followers of technical analysis use this to gauge the strength of a stock market. In particular, if the advance-decline line shows a negative return (that is, more shares fall than rise) yet the stock market index continues to rise, they see this as an indication that the market is weak and as a prelude to a fall in the index.

Advance corporation tax

A taxation system used by the UK government to take a slice of income from the dividends that companies paid to their shareholders. However, advance corporation tax (ACT) had a penal effect on UK-based companies that made most of their profits overseas and was abolished in April 1999. Thus companies no longer have to pay the government 25% of the amount of the dividend that they paid to their shareholders. Correspondingly, shareholders no longer receive a tax credit equal to the value of the ACT paid. The exception to this rule, however, is that private investors still get a small tax credit, equal to 11% of the dividend that they receive, which they can offset against their tax liability.

Accrued interest

The interest that has been earned on a bond since its most recent dividend was paid. The market price for bonds ignores this element; it quotes the price of bonds "clean" of accrued interest. However, a buyer would have to pay for the interest that has accrued. Imagine a bond with a 10% coupon. If it were quoted in the market at $125 120 days after the last dividend had been paid then, ignoring dealing costs, a buyer would have to pay $125 plus 120/365 of $10; that is, $128.29.

Accruals concept

A basic idea on which company accounts are based: that cause and effect should be linked by matching the costs which are incurred in running a business with the resultant revenue earned (although not necessarily received in cash) in the same accounting period. The alternative would be to have a system of cataloging the cash transactions of a business and calling the net result profit or loss. But in any one year this would be likely to distort the picture of the company's performance since many cash costs would be incurred, or income received, in respect of pieces of work that span more than one accounting year.

Asset stripping

A term first coined in the UK in the late 19605 to describe the practice of taking over a company, splitting it into parts and selling them for a profit. It was a derogatory label since it implied no effort on the part of the acquirer to develop the company. By the late 19805 asset stripping was more in tune with the spirit of the times, so when the practice once more swept through the corporations of the UK and the United States it was more likely to be called "financial restructuring".

Asset allocation

The process of deciding in which sorts of assets to make investments and what proportion of total capital available should be allocated to each choice. The task is as relevant to private investors as it is to giant savings institutions. The latter formalize the process rather more, however, often beginning with a top-down approach, which decides both in which asset classes to make investments (shares, bonds, real estate, cash, other classes) and in which geographical areas to invest (North America, Europe, East Asia, emerging markets, for example). Estimates of the likely returns from individual investment choices compared with the target return that the institution seeks will drive the selection process. From this will follow the decision to invest an above-average or below-average proportion of funds in some markets with reference to benchmark weightings that are commercially available.

Asset

For something so fundamental to investment the surprise is that the definition of an asset is so vague. The US accounting standards body has defined it as being "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events". However, within the context of a company's balance sheet, an asset is also a deferred cost. If a company shows plant and equipment of £1m in its balance sheet, that represents past expenditures which have yet to be written off and which, according to the accruals concept of accounting, will be depreciated as the plant is used up. The test of whether the plant is ultimately an asset or a liability will be whether it generates after-tax revenue greater than its cost. For a company to survive, most plant and equipment must pass that test. But for other items which are carried forward as assets, such as the deferred cost of a pension fund, there is no suggestion that they can bring economic benefits.

More generally, the broad categories of investments within a portfolio - shares, bonds, property - are known as assets. Hence the term asset allocation.

Arbitrage pricing theory (APT)

A theory which aims to estimate returns and, by implication, the correct prices of investments. Intellectually, it is an extension of the capital asset pricing model. It says that the CAP-M is inadequate because it assumes that only one factor - the market - determines the price of an investment, whereas common sense tells us that several factors will have a major impact on its price in the long term. Put those factors into a model and you are making progress.

Thus arbitrage pricing theory (APT) defines expected returns on, say, an ordinary share as the risk-free rate of return plus the sum of the share's sensitivity to various independent factors. (Here sensitivity, as with the CAP-M, is defined by the share's BETA.) The problem is to identify which factors to choose. This difficulty is compounded by academic studies which have come up with varying conclusions about the number and identity of the key factors, although benchmarks for interest rates, inflation, industrial activity and exchange rates loom large in tests.

In practice, the aim of using APT would be simultaneously to buy and sell a range of shares whose sensitivity to the chosen factors was such that a profit could be made while all exposure to the effect of the key variables and all capital outlay were canceled out. To the extent that APT assumes that markets always seek equilibrium, it says that the market would rapidly price away such arbitrage profits.

Alternatively, a portfolio could be chosen which could be expected to outperform the market if there were unexpected changes in one or more key factors used in the model, say industrial activity and interest rates. As such, however, that would be doing little more than betting on changes in industrial production and interest rates and would not have much to do with minimizing risk for a given return. Resolving problems such as these means that APT gives greater cause for thought to academics than to investors.

Arbitrage

To arbitrage is to make a profit without risk and, therefore, with no net exposure of capital. In practice, it requires an arbitrager simultaneously to buy and sell the same asset - or, more likely, two bundles of assets that amount to the same - and pocket the difference. Before financial markets were truly global, arbitraging was most readily identified with selling a currency in one financial center and buying it more cheaply in another. The game has now moved on a little, but, for example, there would be the potential to make risk-free profits if dollar interest rates were sufficiently high to allow traders to swap their euros for dollars and be left with extra income after they had covered the cost of their currency insurance by selling dollars forward in the futures market. Similarly, arbitrage opportunities can be exploited by replicating the features of a portfolio of shares through a combination of equity futures and bonds then simultaneously selling the actual stocks in the market. (See risk arbitrage)