Glossary
of Investment Terms

ACTIVE MANAGEMENT

A portfolio
technique that takes explicit bets away from the index (therefore adding risk),
with the objective of outperforming the index and adding additional
investment return known as alpha. (See also: Alpha)

ALPHA

A measure of risk-adjusted
performance with regard to a specified market. A positive alpha is the extra
return awarded to the investor for taking a risk instead of accepting the
market return. It is the abnormal rate of return in excess of what would be
predicted by an equilibrium model. For example, an alpha of 1.0 means the fund
outperformed the specified market by 1.0% on a beta-adjusted basis. (See also:
Beta)

BACK-TESTED INDEX DATA

Historical
index values for dates prior to an index's introduction. The values are hypothetical
and provide an indication of how an index might have performed in the past if
it had existed. Also known as back-cast data or synthetic history. (See also:
Index History)

BASE DATE

The date at
which an index's base value is set.

BASE VALUE

The initial
value with which an index is calculated at a particular starting date or base
date.

BENCHMARK INDEX

An index used
as a basis for comparison in measurement of the performance of an
investment.

BETA

A measure of
volatility in comparison to the market as a whole. It measures risk in relation
to the market or to an alternative benchmark. For example, a beta of 1.5 means
that returns are expected to move 1.5 times the market's returns. Beta is
referred to as an index of the systematic risk due to general market conditions
that cannot be diversified away. A beta of 1 indicates that price will move
with the market. A beta greater than 1 indicates that price will be more
volatile than the market. A beta less than 1 means that it will be less
volatile than the market.

CLOSED INDEX FUND

A fund whose
investment company issues a fixed number of shares in a portfolio of
securities. The shares are traded in the market just like common stock.

CORRELATION

Statistical
measure of the degree to which the movements of two variables are related.

DIVISOR

A placeholder
that serves as the only link to the original base period value of an index. The
divisor keeps the index comparable over time and is the manipulation point for
all index adjustments.

EFFICIENT-MARKET THEORY

The theory
postulating that market prices reflect the knowledge and expectations of all
investors. It asserts that any new development is instantaneously priced
into a security, thus making it impossible to beat the market consistently.

ENHANCED INDEX FUND

An index fund
designed to generally track an index but also to outperform it through the use
of futures, trading strategy, capital gains management, and other methods.

EXCHANGE-TRADED FUND (ETF)

A security that
tracks an index and represents a basket of securities like an index fund.
However, it trades like a stock on an exchange, thus experiencing price changes
throughout the day as it gets bought and sold. ETFs generally have lower
expense ratios and experience greater tax efficiency. By owning an ETF,
you get the diversification of an index fund as well as the right to sell
short, buy on margin, and purchase as little as one share. Some common ETFs are
the Dow Jones Diamonds (DIA), which tracks the Dow Jones Industrial Average;
the Nasdaq-l00 Index Tracking Stock (QQQ), which tracks the Nasdaq-l00; and the
S&P Depositary Receipts (SPY), which tracks the S&P 50O.

EXPENSE RATIO

The percentage
of assets that are used to operate a fund. These include expenses such as
management fees, advisory fees, and overhead costs. The expense ratio does not
include brokerage costs for trading the portfolio.

FLOAT-ADJUSTED SHARES

The number of
shares actually available for purchase by the public on open markets. It is
calculated by subtracting restricted shares—such as those held by company
insiders—from outstanding shares.

INDEX

A statistical
measure of change in an economy or a securities market. In the case of
financial markets, an index essentially measures a particular market or a
portion of it.

INDEX COMMITTEE

A group of
people responsible for periodically reviewing the components, methodology,
goals, and so on of a given index. Not all indexes are governed by a committee;
many are instead maintained based on a quantitative set of rules.

INDEX FUND

A portfolio of
investments that closely reflects the composition of an index in order to
mirror its performance.

INDEX HISTORY

Historical
closing values of an index, typically available either daily or monthly. (See
also: Back-Tested Index Data)

INDEXING

An investment
strategy that aims to replicate the performance of a market or market segment
by using an index as a benchmark.

INDEX METHODOLOGY

A body of
practices, procedures, and rules used in creating and maintaining an index.
Typically, an index's methodology specifies the index universe from which
components are selected, the criteria by which an index's components are
selected, and practices such as weighting procedures, how the index is
calculated, how often is it calculated, and how often it is reviewed.

INDEX TURNOVER

The percentage
of an index's components that change as the result of a periodic composition
review. Can be calculated based on component number or market capitalization.

INDEX UNIVERSE

The pool of
securities from which an index draws its components.

INDUSTRY CLASSIFICATION SYSTEM

A system by
which securities are identified and grouped by their respective industry
sectors. Typically includes several tiers that range from very broad to very
specific groupings.

MARKET CAPITALIZATION

A measure of
the size and value of a corporation, security, fund, or index as determined by
the market price of its issues and outstanding common stock. Market
capitalization is calculated as the product of market price and shares
outstanding = (stock price) x (shares outstanding). Float-adjusted market
capitalization is calculated by substituting shares outstanding with
float-adjusted shares outstanding.

MARKET COVERAGE

A measure of
the degree to which an index includes all of the underlying securities in the
market or market segment that that index represents. Market coverage is
generally expressed as a percentage and is calculated based on market
capitalization.

PASSIVE MANAGEMENT

An investment
strategy that mirrors a market index and does not attempt to beat the market.
Also known as passive investing or a passive strategy.

PRICE-RETURN INDEX

An index that
is calculated with the assumption that cash dividends will not be automatically
reinvested into the index. (See also: Total-Return Index)

REBALANCING

The process of
realigning the weightings of an index or portfolio.

RETURN

The total
percentage gain or loss of an index or investment over a specified time period.

RISK

Often defined
as the standard deviation of the return on total investment.

R-SQUARED

A statistical
measure that represents the percentage of a portfolio's movements that is
explained by movements in a benchmark index. It can range from 0.00 to 1.00. An
R-squared of 1.00 indicates perfect correlation and that all movements of a
fund are completely explained by movements in the index, while an R-squared of 0.00
indicates no correlation.

SECTOR ALLOCATION

Separating and
identifying the distribution of the market capitalization of an index or fund
according to the industry sectors in which the component companies
operate.

SHARPE RATIO

A measure of
return expressed in standard deviation units. The Sharpe ratio is calculated by
dividing excess return over the risk-free rate by its standard deviation.
The higher the Sharpe ratio, the better the risk-adjusted performance.

SIZE INDEX

General term
used to describe indexes defined by capitalization range—generally,
Large-cap, Mid-cap, Small-cap, and Micro-cap indexes.

STYLE INDEX

Measure of
stocks displaying either growth or value characteristics based on one or more
factors. These factors can include but are not limited to price-to-book ratio
(P/B), price-to-sales ratio (P/S), dividend yield, and earnings per share, hi
some indexes, stocks are not exclusively growth or value stocks, and a weighted
percentage may be listed in both style indexes. Other indexes, however, require
that a company be listed in only one style index.

STYLE PURITY

The degree to
which a style index embodies the traits of the style category it represents.
The most style-pure growth index outperforms other growth indexes during
periods when growth stocks lead the market. Likewise, a style-pure value index
outperforms other value indexes during periods when value stocks lead the
market.

TOTAL-RETURN INDEX

An index that is
calculated with the assumption that dividends will be automatically reinvested
into the index. (See also: Price-Return Index)

TRACKING ERROR

The standard
deviation of the difference between the performance of a portfolio and the
index it replicates. Tracking error captures the volatility of the difference
between the return you receive and that of the benchmark you attempt to
replicate.

VOLATILITY

A measure of
risk based on the standard deviation of return.

WEIGHTING

The relative
importance of individual components when combined to form an index, or the
percentage of a portfolio or index that a given stock represents. A component
with a larger weight will have a greater effect on the movement of the index
than would a component with a smaller relative weight. Limits, or caps, may be
set to limit how much weight an individual component may have in an index.

Z SCORE

Statistical
measure that quantifies the distance (measured in standard deviations) a data
point is from the mean of a data set.

SOURCES

indexfunds.com;
investopedia.com; finance.yahoo.com; Barren's Dictionary of Business Terms.