Measuring Return

Question 1

What is the Holding Period Return?

Answer 1

[Selling Price - Purchase Price +/- Cashflows] / Purchase Price OR Equity Invested

not a compounded ROR

no consideration for the time an investment was held

** Exam questions may come from margin returns or after-tax rate of returns

• securities purchased on margin should subtract any interest paid (in numerator)
• security sales should subtract the total cost of securities from sales proceeds, only include equity in trade in the denominator

Question 2

What does the Effective Annual Rate measure?

Answer 2

the effective annual interest rate earned on an investment when the compounding occurs more often than once per year

Question 3

What does the Arithmetic Average measure?

Answer 3

same as the mean or simple average

the sum of all numbers divided by the number of observations

Question 4

What does the Geometric Average measure?

Answer 4

geometric mean, a time-weighted compounded rate of return

the compounded rate of return

Question 5

What factors must be taken into account when calculating a portfolio weighted average return?

Answer 5

1. The current FMV of the securities held
2. The total portfolio value (TPV)
3. The return of each security thought the time period in question.

Portfolio Return Weighted Average

• FMV = value of each security within portfolio holding
• TPV = sum of total portfolio

Weighted Return = Security FMV X TPV X Security % Return

Sum the total weighted returns of each security to get weighted average portfolio return.

Question 6

What does Net Present Value (NPV) measure and how?

Answer 6

used to evaluate capital expenditures that will result in differing cash flows over the useful life or investment period

NPV is deterministic:
- POSITIVE NPV = MAKE THE INVESTMENT
- NPV = 0, MAKE THE INVESTMENT
- NEGATIVE NPV = DO NOT MAKE THE INVESTMENT

NPV = PV of Cash Flows - Initial Cost

Question 7

What does the Internal Rate of Return measure and how?

Answer 7

IRR is the discount rate that sets the NPV formula equal to zero

IRR is a compounded rate of return

IRR should be calculated when you have uneven cash flows and you’re asked to calculate a compounded rate of return

IRR POSITIVE : IRR > Discount Rate
NPV = 0: IRR = Discount Rate
IRR NEGATIVE: IRR < Discount Rate

Question 8

What does the Dollar-Weighted Return measure?

Answer 8

calculates IRR using the investor’s cash flows

• take into account dividends (additions) and additional share purchases (subtraction)

Question 9

What does the Time-Weighted Return measure?

Answer 9

calculates IRR using the security’s cash flow (assumes a buy and hold)

DOES NOT TAKE INTO ACCOUNT ADDITIONAL PURCHASES

concerned with growth since initial purchase

MUTUAL FUNDS REPORT ON A TIME-WEIGHTED BASIS

Question 10

What is the difference between dollar-weighted and time-weighted return variables?

Answer 10

Dollar-weighted uses all cash flows

Time-weighted only uses initial purchase, dividends, and final sell (assumes buy and hold)

Question 11

What does Arbitrage Pricing Theory (APT) measure and how?

Answer 11

asserts that pricing imbalances cannot exist for any significant period of time

MULTI-FACTOR MODEL that attempts to explain return based factors

• FACTORS OF ZERO HAS ON IMPACT ON RETURN

attempts to take advantage of pricing imbalances

inputs are factors (F) such as inflation, risk premium, and expected returns and their SENSITIVITY TO THOSE FACTORS

• Std dev and Beta are not input variables

Question 12

How do you determine foreign currency translation?

Answer 12

1. Convert USD to the foreign currency to determine the cost.
2. Compute the return, typically utilizing the HPR calculation.
3. Covert the foreign currency back to USD.