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Appendix D. Selected definitions

Broad-based Index

Broad-based Index at InvestorWords
Broad-based Index at Investopedia

Cost of Carry

Cost of Carry at InvestorWords

Dividend Yield

Dividend Yield, as used in current review, determines continuously compounded rate of return paid on an asset.
Selecting an appropriate value for dividend yield allows correct evaluation of such financial instruments, included in portfolio, as currency rates, futures and coupon bonds.
  • Currency Exchange Rates
    Dividend yield must be set to the difference between continuously compounded foreign interest rate and domestic interest rate.
  • Futures
    Dividend yield must be equal to
    cost of carry (expressed in the form of continuously compounded rate of return) in the contract under consideration.
  • Coupon Bonds
    Dividend yield must be equal to coupon rate (once again, its continuously compounded counterpart must be taken).

Efficient Market

Efficient Market at InvestorWords

Index Fund

Index Fund at InvestorWords

Investment Horizon

The Investment Horizon is a critical date for the investor: when reaching it he/she evaluates success made by the investments. For private persons such date often corresponds to the moment up to which they
postpone their consumption. So, for example, it can be scheduled date of a large purchase, an expected birth of a child or the moment of retire.1For portfolio manager the investment horizon is equal, as a rule, to one or two years: after this time the management estimates his work and on the basis of results the manager receives bonus for the specified period.
It should be noted that the gap, formed thus between an investment horizon of the investor and of his portfolio manager is one of the problems that the managment company comes across and which rarely attracts sufficient attention. (see
[Cvitanic, Lazrak, Wang; 2006] ).

Investment Horizon at InvestorWords

Market Portfolio

Market Portfolio at InvestorWords

Risk-free Rate

The Risk-free Rate (or Riskless Rate) is continuously compounded rate earned on riskless asset. If Cash (Bank Account) is used as riskless asset, then risk-free rate corresponds to bank account interest rate. Otherwise, if the riskless asset differs from cash, then risk-free rate is equal to dividend yield for that asset.

Riskless Asset

Riskless Asset or Risk-free Asset (other common notation is Numeraire) it is an asset, in units of which the investor measures his welfare. In an ideal the investor should be indifferent to changes in value
of the riskless asset.

As a rule, the choice of riskless asset is adhered to investor’s expenses. For example, if the investor carries the most part of expenses in US dollars, then the most natural choice of welfare measure would also
correspond to US dollars. Common choices for riskless asset:

  1. Cash (bank account, denominated in domestic currency) – better suits for short-term investments since it doesn’t account for the inflation risk.
  2. Fixed-Coupon Bond
  3. Inflation-Linked Bond – the best choice for the long-term investments of pension funds Foreign Currency or Currency Basket
  4. Broad-based Index natural choice for many fund managers, whose task consists in maximizing the growth of investments relative to the selected index.

Wiener Process

Wiener Process at Wikipedia
Brownian motion RiskGlossary

1The latter example of an investment horizon is slightly incorrect. When investing the retirement savings one should select as his investment horizon the date corresponding to the expected life span of the family members rather than the moment of retirement itself.
The above observation comes from the fact that the pensionary consumption, as a rule, is uniformly extended in time, so the average length of the investment period in this case significantly exceeds time left up to the retirement.

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