Glossary of Financial Terms
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Value at Risk (VaR)
It is an encompassing measure of the risk for a portfolio. In the early 90’s J.P. Morgan invented it upon the order of Chairman, Dennis Weatherstone. Legends have it that he demanded that his staff save all the boring technicalities and basically tell him how much money the company may lose tomorrow. With a lot of sweating and some ingenuity, VaR emerged and it was dubbed the 4:15pm report. (Picture this in your mind: Weatherstone glances with approval over the single-page VaR report at 4:15pm before he heads home.)
Fundamentally, VaR is an estimate of maximum loss during a specific horizon with a certain level of confidence. Suppose a portfolio is worth $500 million, currently. If we state that with 99% confidence, the loss over the next 10 days will not go beyond $15 million, then in this case the VaR over the 10-day period is $15 million at the 99% confidence level. Obviously, the higher the confidence level, the larger the VaR number. The extreme case: we are 100% confident that the loss will not exceed $500 million over the next ten days. But this is an empty statement!
Due to its simplicity, VaR became a universally accepted risk measure and the centerpiece of Basel Accord II.
Also see “Basel Accords.”
Value Stock
Stock of a company that is on solid footing, making profits, but for some reason, neglected by investors. It is synonymous to undervalued stocks. These stocks typically have a lower P/E ratio but a higher dividend yield. They are usually preferred by patient bargain hunters. The legendary Warren Buffett of Omaha is a popular example of value investors.
It must be noted that some glamor stocks will lose luster in the long run, just as not all value stocks will realize superior returns. Some seemingly undervalued stocks do perish, eventually; and a number of glittering stocks do become dogs. How can one identify genuine growth and value stocks, precisely? There is no specifically known way.
Also see “Price Earnings Ratio (P/E)” and “Dividend Yield.”
Variable-rate Mortgage
A mortgage whereby the rate floats with the market and can be modified at any time by the bank. Each time the rate is adjusted, a new monthly payment will be calculated for the rest of the balance. When the rate goes up, the monthly payment will go up as well, and vice versa. Those customers who opt for a variable rate anticipate the rate to lower down.
Please see “Mortgage” and “Fixed-rate Mortgage” for related information.
Venture Capital
A specific type of private equity. More particularly, it refers to investments in more risky businesses in their early development stages. Venture capital can be further classified into more specific categories according to the business development stage. For example, “seed capital” is money invested in the earliest stage of a business which may only display some promise of a product; “usual stage of venture capital” is investment in a venture that is already turning a profit; and “later stage of venture capital” is investments in businesses that have existing, fully developed products and are ready for expansion, and so on.
Of course, venture capital investments are highly risky. Based on statistics, 10% of ventures simply go bust, and 50% fail to produce profits. Among the 40% that do succeed, 35% are mediocre, and only 5% are true homeruns. Generally, for most private equity firms, the 5% homeruns make up more than 80% of the total gains. Case in point: Kleiner Perkins (U.S. venture firm) purchased 25% of Netscape for $20m. Afterwards, Netscape was acquired by AOL for $4 billion. Return: 25% × ($4,000m) / ($20m) = 5,000%!!!
Knowing the inherent high risk, only about 20% of private equity firms make venture capital investments.
See also “Private Equity,” “Buyout” and “Leveraged Buyout.”
VIX
Investors’ encompassing measure assessment of the overall market volatility for the nearest future. It is also regarded as a gauge of investors’ fear. Since it is a measure of volatility, it is expressed as a standard deviation of returns in percentage form. For instance, the VIX stands at 19.60 on October 9, 2013, therefore, investors collectively believe that the annualized market volatility for the next little while will be 19.60%. The calculation of VIX is not simple and in fact complicated. In essence, it is the average of volatilities implied from short term options on the S&P 500 index. Since we observe option values together with the index level, we can make use of certain option pricing models (e.g., the Black-Scholes option pricing model) to calculate an implied volatility of the S&P 500 index (i.e., to back out a volatility that will make the model price equivalent to the observed market price of the option). Insofar as S&P 500 is a barometer of the overall equity market in the U.S., its implied volatility is representative of investors’ assessment of the overall market volatility. VIX is computed such that it always measures the volatility for the next 30 days.
See “Volatility,” “Option,” “Black-Scholes Option Pricing Model/Formula” and “S&P 500.”
Volatility
It usually pertaining to the riskiness of a stock. When we say a particular stock is very volatile or has a high volatility, we can deduce that its price fluctuates a great deal. Frequently, we use the standard deviation of the stock’s return to measure volatility.
Volcker Rule
Named after the former Chairman of the Federal Reserve (under Presidents Jimmy Carter and Ronald Reagan), Paul Volcker who served from 1979 to 1987, the Volcker Rule is a main component of the Dodd-Frank Act.
Preceding the Financial Crisis of 2007, banks and other deposit taking institutions were allowed to perform both an advisor’s role as well as a creditor’s role to the same client (e.g., in a leveraged buyout situation). They were likewise allowed to trade on their own accounts, an activity called proprietary trading. Mr. Volcker strongly believed that deposit taking institutions’ engagement in such practices constituted a severe form of conflict-of-interest and hence ought to be presented.
The Volcker Rule contains explicit stipulations. Basically, it requires that depositing taking institutions separate such activities as investment banking, private equity and proprietary trading from their consumer lending activities.