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The correlation coefficient is a measure that determines the degree to which two variables' movements are associated. The range of values for the correlation coefficient is -1.0 to 1.0. If a calculated correlation is greater than 1.0 or less than -1.0, a mistake has been made. A correlation of -1.0 indicates a perfect negative correlation, while a correlation of 1.0 indicates a perfect positive correlation.
While the correlation coefficient measures a degree to which two variables are related, it only measures the linear relationship between the variables. Nonlinear relationships between two variables cannot be captured or expressed by the correlation coefficient.
A value of exactly 1.0 means there is a perfect positive relationship between the two variables. For a positive increase in one variable, there is also a positive increase in the second variable. A value of exactly -1.0 means there is a perfect negative relationship between the two variables. This shows the variables move in opposite directions; for a positive increase in one variable, there is a decrease in the second variable. If the correlation is 0, this simply means there is no relationship between the two variables. The strength of the relationship varies in degree based on the value of the correlation coefficient. For example, a value of 0.2 indicates there is a positive relationship between the two variables, but it is weak.
This type of statistic is useful in many ways in finance. For example, it can be helpful in determining how well a mutual fund is behaving compared to its benchmark index, or it can be used to determine how a mutual behaves in relation to another fund or asset class. By adding a low or negatively correlated mutual fund to an existing portfolio, diversification benefits are gained.
Form ADV is the uniform form used by investment advisers to register with both the Securities and Exchange Commission (SEC) and state securities authorities. The form consists of two parts. Part 1 requires information about the investment adviser's business, ownership, clients, employees, business practices, affiliations, and any disciplinary events of the adviser or its employees. Part 1 is organized in a check-the-box, fill-in-the-blank format. The SEC reviews the information from this part of the form to process registrations and manage its regulatory and examination programs. Although designed for a regulatory purpose, investment adviser filings of Part 1 are available to the public on the SEC's Investment Adviser Public Disclosure (IAPD) website at www.adviserinfo.sec.gov.
Beginning in 2011, Part 2 requires investment advisers to prepare narrative brochures written in plain English that contain information such as the types of advisory services offered, the adviser's fee schedule, disciplinary information, conflicts of interest, and the educational and business background of management and key advisory personnel of the adviser. The brochure is the primary disclosure document that investment advisers provide to their clients. When filed, the brochures are available to the public on the IAPD website.
An agency transaction is the other popular method for executing a client's orders. More complicated than regular principal transactions, these deals involve the search for and transfer of securities between clients of different brokerages. The increasing number of participants in the securities market and the need for extremely accurate bookkeeping, clearing, settlement and reconciliation make ensuring the smooth flow of the securities markets quite a task.
Agency transactions are comprised of two distinct parts. First, your brokerage needs to bring your request to the appropriate market in order to find a party wishing to assume the opposite position. So, if you wish to buy at a certain price, the broker needs to find someone wishing to sell at the same price and vice versa. Once both parties are found, the exchange records the transaction on its ticker tape, and an exchange of money and securities between the parties occurs on settlement.
The second portion of the agency transaction occurs after the trade is completed and has been properly documented on the exchange. This portion is commonly referred to as clearing. While all brokers maintain individual books recording the entire amount of buy and sell orders transacted by clients, the actual act of clearing these transactions is handled by a larger institution. In North America, the institution handling the vast majority of clearing and safekeeping duties is the Depository Trust Clearing Corporation (DTCC).