Chapter 1 - Compounding

Question 1

What is the formula for continuous compounding?

Answer 1

FV = PV(1+r)^n

Question 2

Rate of Return (r)

Answer 2

n square root (FV/PV) - 1 = r

All spin offs of FV = PV(1+r)^n

Question 3

AER/APR/EAR

To calculate the correct rate of return taking into consideration interest payments made at intervals more frequent than annually -

And considering the subsequent returns for the remainder period are based on the original capital plus the interest payments paid throughout the term

Answer 3

AER/APR/EAR

= (1+r/n)^n

Question 4

AER/APR/EAR

To establish the annual rate from the monthly rate

Calculates an annual effective rate from the monthly rate of interest

Annualised Returns ….

Answer 4

APR

= (1+monthly rate)^12 - 1

Annualised returns - similar but with ^1/n rather than 12

An=(1+return)^1/n - 1

Question 5

REGULAR SAVINGS - FV
ACCUMULATION

Calculates the FB of a series of payments plus interest

ANNUITIES - calculates lump sum required, PV generate a stream of income/payments over a set term at a set rate

Answer 5

F = P x (1+r)^n - 1/r

A = P x {1-(1+r)^-n} / r

Question 6

Real return

Answer 6

Real return = nominal return minus inflation

Question 7

Holding Period Return

Calculates the return on an investment (incl DVDs & Wdls) as a % of the original amount

Answer 7

HPR = D + V1. - V0 / V0

Question 8

Money weighted return - MWR

Calculates the return on an investment, adjusted for any cash flows into the portfolio over the term

Time Weighted Return - TWR

Allows for comparison of performance btw diff FMs as it minimises distortion caused by the timing of cash flows which may be outside the FM control

Answer 8

MWR =
D+V1-V0-C / V0+(C x n/12)

TWR =

1+r = (1+R1) x ( 1+ R2) … (1+R3) etc