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The Efficiency Test is a key risk management tool. It is the cost of the cheapest dynamic trading strategy, trading some reference index and cash, which generates the same payoff distribution as the hedge fund. First, a payoff function is constructed that, in combination with the distribution of the reference index, yields the same end-of-month payoff distribution as the fund. Second, this payoff function is priced using standard option pricing technology. The Efficiency Test can be interpreted as a highly generalized Sharpe Ratio (see Sharpe ratio). Due to its dynamic nature, it is able to deal with any type of return distribution.

In economic theory, an efficient market is one in which market prices adjust rapidly to reflect new information. The degree to which the market is efficient depends on the quality of information reflected in market prices. In an efficient market, profitable arbitrage opportunities do not exist and traders cannot expect to consistently outperform the market unless they have lower-cost access to information that is reflected in market prices or unless they have access to information before it is reflected in market prices. See Random Walk.

A trading facility that operates by an electronic or telecommunications network instead of a trading floor and maintains an automated electronic audit trail of transactions. See Exchange.

The net worth of a company. This represents the ownership interest of the shareholders (common and preferred) of a company. For this reason, shares are often known as equities.