Glossary of Terms

Credit Risk: The risk that a borrower may default on a loan, a bond or other debt instrument, leading to potential financial loss for the lender.

Duration Risk: The risk that changes in prevailing market interest rates will cause the market value of a fixed-income investment, such as a bond, to drop.

Liquidity Risk: The risk that an asset cannot be sold quickly enough at a fair price because there are not enough buyers or the market is otherwise disrupted.

Correlation: The degree to which the value of two assets changes with respect to one another.  Correlation is expressed as a value from -1.0 to +1.0.  If two assets have correlation of -1.0 then when one asset appreciates, the other asset depreciates.  If two assets have correlation of +1.0 then when one asset appreciates so does the other asset.  If two assets have a correlation of 0.0 then the appreciation/deprecation of one asset is unrelated to that of the other asset.

Volatility: The degree of variation in values, showing how widely an asset’s value swings around its average.  It is not about the direction of the change (up or down), but rather the magnitude and speed of the changes.

Max Drawdown: The largest percentage drop an asset takes from its highest peak value to its lowest trough value over a specific period before reaching a new high.

Sharpe Ratio: A financial metric used to measure the risk-adjusted return of an investment or portfolio.  It is calculated by measuring an asset’s annualized excess return and dividing by that asset’s volatility.  Excess return is the asset’s total return minus the risk free rate.