Glossary

Book-to-market ratio

The book-to-market ratio compares a company’s book value to its market value. It is calculated as:
\[ \text{book-to-market ratio} = \frac{\text{total assets}}{\text{market value}} \]

A higher ratio indicates the company may be undervalued or “cheap” relative to its accounting value, while a lower ratio suggests it might be relatively expensive.

Book value

The book value is quite literally the value of a business according to its books, as determined by its financial statements. It represents the accounting value of all assets (buildings, machinery, inventory) minus all liabilities (debts).
\[ \text{book value} = \text{total assets} - \text{total liabilities} \]

Market value

The market value of a publicly traded company is the value assigned by the stock market, known as market capitalization. It is calculated as:
\[ \text{market cap} = \text{price per share} \times \text{number of outstanding shares} \]

Risk-free rate

The risk-free rate is the return an investor would expect from an investment with (nearly) zero risk of financial loss over a given horizon. Typically, returns of government bonds with short maturity are used, given the very low chance for governments to default on their debt. Risk-free rates are used as a baseline to compare other investments and to price risk.

Rolling window

In finance, a rolling window is a technique used to analyze data over a continuously shifting time period. Instead of evaluating performance or risk over a fixed interval (ex, 1980-2020), a rolling window updates the start and end points as time moves forward, keeping the window length constant.

As an example, a 5-year rolling window with 1-year shifts works as follows:

1. Take the first 5 years from your data (ex, 1980 to 1985).
2. Compute the metric you’re interested in (returns, volatility, etc.)
3. Shift the window forward by one year (1981 to 1986), and go to step 2.

This process reveals how metrics evolve over time, reducing short-term noise and highlighting longer-term trends

Sharpe ratio

Sharpe ratio is a measure that expresses how much higher (or lower) a return an investor can expect compared to the risk-free rate of interest per unit of risk (volatility). Generally, the higher the Sharpe ratio, the more attractive the risk-adjusted return.

Tracking error

Tracking error is a measure of the deviation of a fund's return compared to the return of a benchmark over a fixed period, expressed as a percentage. The more passively the investment fund is managed, the smaller the tracking error.

Turnover

Fund turnover in finance measures how actively a fund trades its holdings over a period, usually a year. It’s expressed as a percentage relative to the total amount of assets under management. High turnover indicates regular trading, often leading to higher costs and potentially more taxable events. Low turnover suggests a buy-and-hold strategy, typically lower costs, and tax efficiency.