IFoA SP10 key terms

The weighted average time until a bond's cash flows are received, with weights being the present values of those cash flows. It measures a bond's sensitivity to small parallel shifts in interest rates.

Macaulay duration divided by one plus the yield per period. It approximates the percentage change in a bond's price for a one percentage point change in yield, assuming the yield curve shifts in parallel.

The second-order sensitivity of a bond's price to changes in yield, capturing how duration itself changes as yields move. Positive convexity means price gains exceed losses for equal-sized yield moves, making the bond more valuable.

A strategy that matches the duration of assets to the duration of liabilities so that a portfolio's surplus is protected against small parallel interest rate shifts. It typically requires periodic rebalancing as durations drift.

A graph of yields on bonds of equal credit quality against their time to maturity. Its level, slope and shape inform expectations of future rates, growth and inflation and drive bond pricing and relative value decisions.

The difference between the yield on a corporate or other non-government bond and the yield on a comparable government bond. It compensates investors for default, illiquidity and other risks.

The chance that a bond issuer fails to pay interest or principal when due. It is assessed through credit ratings and fundamental analysis and is priced into the credit spread investors demand.

An independent agency's opinion of an issuer's or debt issue's creditworthiness, expressed on a letter scale from high investment grade to speculative default-prone levels. Ratings guide eligibility and capital charges.

An equity valuation approach that values a share as the present value of its expected future dividends, discounted at a rate reflecting required return. Simple versions assume constant dividend growth in perpetuity.

A share's market price divided by its earnings per share. It expresses how much investors pay for each unit of earnings and is used to compare relative value across stocks and markets.

Earnings per share divided by the share price, the reciprocal of the price-earnings ratio. Expressing equity earnings as a yield allows direct comparison with bond yields in asset allocation.

The additional expected return investors require for holding equities rather than risk-free assets. It is a key input to discount rates, expected return assumptions and strategic asset allocation.

Cash generated by a business after capital expenditure needed to maintain and grow operations. It funds dividends, buybacks and debt repayment and underpins many intrinsic valuation models.

The total value of a business to all capital providers, calculated as market capitalisation plus debt and other claims less cash. It is used with EBITDA in relative valuation multiples.

The value of a fund's or property vehicle's assets minus its liabilities, usually expressed per share or unit. For open-ended funds it is struck regularly and sets the price at which units are created or redeemed.

A collective investment vehicle that issues and redeems units on demand at a price based on net asset value. Liquidity mismatches can arise when underlying assets, such as property, are slow to sell.

The extra expected return investors demand for holding assets that cannot be sold quickly without a price concession. It is relevant to property, private equity, infrastructure and other alternative assets.

Investments outside traditional listed equities and bonds, such as private equity, infrastructure, hedge funds and commodities. They may offer diversification and higher returns but bring valuation, liquidity and governance challenges.

Annual rental income from a property expressed as a percentage of its capital value. It reflects income return and, compared with bond yields, helps judge relative value and the scope for rental growth.

Combining assets whose returns are not perfectly correlated to reduce portfolio risk without necessarily lowering expected return. Its benefit depends on correlation, weights and the number of holdings.

A standardised measure between minus one and plus one of how closely two series of returns move together. Lower correlation between assets increases the risk-reduction benefit of combining them.

The set of portfolios offering the highest expected return for each level of risk, or lowest risk for each return, under mean-variance assumptions. Portfolios below it are inefficient.

The long-term mix of asset classes chosen to meet an investor's objectives and risk tolerance, reflecting expected returns, correlations and liabilities. It is the main driver of long-run portfolio outcomes and is reviewed periodically.

Short-term deviations from the strategic asset mix intended to exploit market views or relative value. Positions are usually constrained by risk budgets and must be justified against the strategic benchmark.

Projecting asset and liability cash flows and values under many economic and demographic scenarios to test funding and solvency outcomes. It informs investment strategy, contribution and capital decisions for insurers and pension schemes.

The ratio of a pension scheme's assets to the present value of its liabilities. A funding level below one hundred per cent indicates a deficit requiring contributions, investment returns or benefit changes.

The excess of assets over liabilities measured on a chosen basis. Insurers and pension schemes manage investment strategy to protect and grow surplus while controlling the risk of a deficit.

A financial contract whose value depends on an underlying asset, rate or index, such as a future, option or swap. Derivatives are used to hedge risk, adjust exposure or take speculative positions.

An agreement between two parties to exchange cash flows, often fixed for floating interest or one currency for another. Interest rate swaps are widely used to change the duration of a portfolio.

A contract exchanging fixed-rate payments for floating-rate payments on a notional principal. Paying fixed in a swap increases liability-matching sensitivity, while receiving fixed reduces it.

A contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset at a set price before or on a stated date. Options provide asymmetric payoffs used for hedging and income strategies.

Adjusting a position in the underlying asset or another derivative to offset the sensitivity of an option position to small moves in the underlying price. It requires frequent rebalancing as the delta changes.

An estimate of the maximum loss a portfolio could suffer over a stated horizon at a given confidence level. It is widely used in risk reporting but ignores losses beyond the threshold and relies on model assumptions.

Evaluating a portfolio's or firm's resilience to severe but plausible adverse scenarios, such as sharp rate rises or market crashes. It complements statistical risk measures by exposing tail and liquidity risks.

Assessing outcomes under a set of internally consistent hypothetical economic and market conditions rather than a probability distribution. It supports capital planning, investment strategy and risk limit setting.

The standard deviation of the difference between a portfolio's return and its benchmark return. It measures active risk and constrains how far a manager may deviate from the benchmark.

Excess return over the benchmark divided by tracking error. It measures the consistency of active management, indicating how much outperformance is earned per unit of active risk taken.

Decomposing a portfolio's return relative to a benchmark into sources such as asset allocation, security selection and currency effects. It explains why performance differed and informs manager and strategy decisions.

The return on an investment assumed to carry no default risk, often proxied by short-dated government securities. It is the foundation for discounting, required return estimates and risk premia.