Glossary of Terms

Agency Securities
Securities issued by U.S. government agencies, such as the Federal Home Loan Bank. These securities have high credit ratings but are not backed by the full faith and credit of the U.S. government.

Asset
Anything owned that has value; any interest in real property or personal property that can be used for payment of debts.

Asset Backed Securities
Financial instruments collateralized by one or more types of assets including real property, mortgages, and receivables.

Banker’s Acceptance (BA)
A high-quality, short-term negotiable discount note, drawn on and accepted by banks that are obligated to pay the amount at maturity.

Basis Point (bp)
The smallest measure used in quoting yields or returns. One basis point is 0.01% of yield, 100 basis points equals 1%. A yield that changed from 8.75% to 9.50% increased by 75 basis points.

Benchmark
A standard unit used as the basis of comparison; a universal unit that is identified with sufficient detail so that other similar classifications can be compared as being above, below, or comparable to the benchmark.

Book Value (BV)
The value of individual assets, calculated as actual cost less allowance for any depreciation. Book value may be more or less than current market value.

Capital Gain
Also known as capital appreciation, capital gain measures the increase in value of an asset over time.
Carrying Amount
(See book value definition above.)

Certificates of Deposit (CDs)
A debt instrument issued by banks, usually paying interest, with maturities ranging from seven days to several years.

Collateral
Property offered as security, usually as an inducement to another party, to lend money or extend credit.

Collateralized Mortgage Obligations (CMOs)
Mortgage-backed securities, segmented into tranches, so that investors can choose a tranche that fits their desired timing of payments.

Commercial Paper
Short-term, unsecured, discounted notes issued by institutional borrowers and sold to investors for short term cash investment needs.

Corporate Bond 
A debt obligation issued by a corporation. 

Coupon
A certificate that accompanies a bond that indicates the amount of interest it pays and the date it is due. The interest is expressed as an annual percentage of the par value of the bond, and may be paid monthly, quarterly, semi-annually, annually, or at maturity. The certificate must be presented for payment either physically or electronically.

Diversification
The spreading of risk by putting assets in several categories of investments, i.e., stocks, bonds, money market instruments, or a mutual fund with its broad range of stocks in one portfolio.

Endowment Funds
Those funds that have been given to the State of Arizona and held in perpetual trust, the investment of which is made on behalf of designated beneficiaries. Composed primarily of proceeds from sales of donated land, only interest earned can be deemed expendable by beneficiaries. As the principal investment is to be held in perpetuity, maturities tend to be longer.

Federal Funds Rate
The interest rate charged by banks with excess reserves at a Federal Reserve district bank to banks needing oversight loans to meet reserve requirements. The federal fund rate is one of the most sensitive indicators of the direction of interest rates since it is set daily by the market.

Federal Reserve Board
The governing body of the Federal Reserve System (12 regional federal banks monitoring the commercial and savings banks in their regions). The board establishes policies on such key matters as reserve requirements and other regulations, sets the discount rate, and tightens or loosens the availability of credit in the economy.

Fixed Income Security
A security such as a bond that pays a specified cash flow over a specific period of time.

Index
A benchmark used in executing investment strategy that is viewed as an independent representation of market performance. An index implicitly assumes cost-free transactions; some assume reinvestment of income.

Investment Income
The equity dividends, bond interest, and/or cash interest paid on an investment.

Liability
The claim on the assets of a company or individual – excluding ownership equity. The obligation to make a payment to another.

Liquidity
Liquidity refers to the degree of speed and ease with which an asset can be converted to cash. 

Marking to Market
Process of determining the value of an asset based upon the going market rate for like assets on any given day.

Market Value
The price at which buyers and sellers trade similar items in an open marketplace. Bonds are considered liquid and are therefore valued at a market price.

Maturity Date
The date on which the principal amount of a bond or other debt instrument becomes payable or due.

Modified Duration
The weighted average time to receipt of all cashflows, including coupon payments, on a present value basis. For corporate bonds, cashflows to the stated maturity date are used, regardless of any options features. For mortgage-backed securities (pass-throughs, C.M.O.s and A.R.M.s), cashflows are derived from the PSA/CPR for the security.

Money Market Fund
An open-ended mutual fund that invests in commercial paper, bankers’ acceptances, repurchase agreements, government securities, certificates of deposit, and other highly liquid and safe securities and pays money market rates of interest. The fund’s net asset value remains a constant $1 per share; only the interest rate goes up or down.

Moody’s Investors Service
A financial services company that is one of the best known bond rating agencies in the country.

Moody’s Corporate Ratings
Moody’s ratings provide investors with a simple system of gradation by which the relative investment qualities of a bond may be noted. Moody’s applies numerical modifiers, 1, 2, and 3, in each generic rating classification from Aa to B. The modifier 1 indicates that the company ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the company ranks in the lower end of its generic rating category.
     Aaa
Bonds which are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as “gilt edged.” Interest payments are protected by a large or exceptionally stable margin, and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues.
     Aa
Bonds which are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in the Aaa securities, or fluctuation of protective elements may be of greater amplitude, or there may be other elements present that make the long-term risk appear somewhat larger than the Aaa securities.
     A
Bonds that possess many favorable investment attributes and are to be considered as upper-medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present that suggest a susceptibility to impairment sometime in the future.
     Baa
Bonds that are considered as medium-grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and, in fact, have speculative investment characteristics as well.
     Ba
Bonds that are judged to have speculative elements; their future cannot be considered as well-assured. Often, the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class.
     B
Bonds that generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small.
     Caa, Ca, C
These ratings are regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. (Ratings definitions reprinted from Moody’s Bond Record, January, 1997. Caa, Ca, C ratings definitions have been summarized.)

Moody’s Short-term Debt Ratings
Moody’s short-term debt ratings are opinions of the ability of issuers to repay punctually senior debt obligations. These obligations have an original maturity not exceeding one year, unless explicitly noted.
     Prime-1
Issuers rated P-1 have a superior ability for repayment of senior short-term debt obligations. P-1 repayment ability will often be evidenced by many of the following characteristics:
•    Leading market position in well established industries. High rates of return on funds employed.
•    Conservative capitalization structure with moderate reliance on debt and ample asset protection.
•    Broad margins in earnings coverage of fixed financial charges and high internal cash generation.
•    Well-established access to a range of financial markets and assured sources of alternative liquidity.
     Prime-2
Issuers rated P-2 have a strong ability for repayment of senior short-term debt obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Earnings trends and coverage ratios, while sound, may be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternative liquidity is maintained. (Only P-1, P-2 ratings definitions have been presented here. Consult Moody’s Investor Service for ratings in entirety.)

Mortgage-backed Security
Ownership claim in a pool of mortgages or an obligation that is secured by such a pool. Also called a pass-through, because payments are passed along from the mortgage originator to the purchaser of the mortgage-backed security.

Non-endowment Funds
Composed of various trust monies invested on behalf of Arizona’s state agencies, as well as local governments. Liquidity needs are greater, as these monies are used for agency operations. Therefore, securities purchased with these monies tend to have shorter maturities. Principal and interest are deemed expendable as directed by Arizona Revised Statutes.

Operating Monies
Those monies invested by the State Treasurer, the earnings of which are not statutorily returned to any specific fund, and therefore, accrue to the state general fund by default.

Par Value
The stated or face value of a stock or bond. It has little significance for common stocks, however, for bonds it specifies the payment amount at maturity.

Pooling
Combining of assets of different entities, i.e., two or more counties, for efficient investment purposes while maintaining separate accounting trails. 

Present value
The current value of a future cash flow or series of cash flows discounted at an appropriate interest rate or rates. For example at a 12% interest rate, the receipt of one dollar a year from now has a present value of $0.89286.

Principal
Face value of an obligation, such as a bond or a loan, that must be repaid at maturity.

Prudent Person Rule
The standard adopted by some states to guide those fiduciaries with responsibility for investing money of others. Such fiduciaries must act as a prudent man would be expected to act, with discretion and intelligence, to seek reasonable income, preserve capital, and, in general, avoid speculative investment.

Realized Gain (Loss)
A gain (loss) that has occurred financially. The difference between the principal amount received and the cost basis after the sale of an asset.

Repurchase Agreements (“Repos”)
An agreement to purchase securities from an entity for a specified amount of cash and to resell the securities to the entity at an agreed upon price and time. Repos are widely used as a money market instrument.

Reverse Repurchase Agreement
A customer sells a group of securities to a broker-dealer under the provision that the customer will buy them back by a predetermined date for a specific price. The difference between the amount the customer received for the securities and the amount he or she will pay the broker-dealer when buying them back represents the interest. 
Salomon Brothers Broad Investment-Grade (BIG) Bond Index
The BIG Index is a market-capitalization weighted index which includes fixed-rate Treasury, government sponsored, corporate (Baa3/BBB- or better), and mortgage securities. All issues mature in one year or more and have at least $50 million face amount outstanding for entry in the BIG Index.

Securities Lending
A carefully collateralized process of loaning portfolio positions to custodians, dealers, and short sellers who must make physical delivery of positions. Securities lending can reduce custody costs or enhance annual returns.

Standard and Poor’s (S&P)
A financial services company which is one of the best known bond rating agencies in the country.

Treasury Bill (T-Bill)
Short-term, highly liquid government securities issued at a discount from the face value and returning the face amount at maturity.

Treasury Bond or Note
Debt obligations of the Federal government that make semiannual coupon payments and are sold at or near par value in denominations of $1,000 or more.

Tri-Party Repo
In a tri-party repo, an independent institution enters into a tripartite agreement with the two counter-parties to the transaction. The third-party custodian assumes certain responsibilities with respect to safeguarding the interests of both counter-parties and is involved in effecting the transfer of funds and securities between the two parties.

Tripartite
Relating to or executed by three parties: a tripartite agreement. 

Trust
A fiduciary relationship in which a person, called a trustee, holds title to property for the benefit of another person, called a beneficiary.

Unrealized Gain (Loss)
A profit (loss) that has not been realized through the sale of a security. The gain (loss) is realized when a security or futures contract is actually sold or settled.

Yield
The return on an investor’s capital investment.

Yield Curve

A graph showing the term structure of interest rates by plotting the yields of all bonds of the same quality with maturities ranging from the shortest to the longest possible. The Y-axis represents the interest rate and the X-axis represents time with a normal curve being convex in shape.

Yield to Maturity
A measure of the average rate of return that will be earned on a bond if held to maturity.