Chapter 3 Quantitative Foundations Flashcards
What is the general term denoting compound interest when the interest is not continuously compounded?
Discrete compounding
What is the primary challenge that causes difficulty in calculating the return performance of a forward contract or other position that requires no net investment? How is that challenge addressed?
Forward contract has a starting value of zero, it would cause division by zero.
Computing returns on derivatives is to base the return on notional principal.
Collateral
What distinguishes a fully collateralized position in this forward contract from a partially collateralized position?
A fully collateralized position is paired with a quantity of capital equal in value to the notional principal of the contract whereas a partially collateralized position is paired with collateral lower in value the notional value
IRR is estimated for a fund based on an initial investment when the fund was created, several annual distributions and an estimate of the fund’s value prior to its termination. What type of IRR is this?
Since Inception IRR
An investment has two solutions for its IRR. What can be said about the investment and the usefulness of the two solutions?
There are two sign changes int eh cash flow stream of the investment. None of the IRRs should be used.
Two investments are being compared to ascertain which investment would add the most value to a portfolio. Both investments have simplified cash flow patterns of an initial cost followed by positive cash flows. Why might the IRRs of the investment provide an unreliable indication of which investment adds more value?
The major challenges with comparing IRRs across investments is when investments have scale differences. Scale differences are when investments have unequal sizes and/or timing of their cash flows.
An analyst computes the IRR of one alternative to be 20% and another to be 30%. When the analyst combines the cash flows of the two alternatives into a single investment, must the IRR of the combinations be greater than 20% and less than 30%?
No. The answer is not immediately apparent because the IRR of a portfolio of two investments is not generally equal to a value-weighted average of the IRRs of the constituent investments. If the cash flows from two investment are combined to form a portfolio, the IRR portfolio can vary substantially from an average the IRRs of the two investments.
Is and IRR a dollar-weighted return or a time-weighted return? Why?
Dollar-weighted
In which scenerio will a clawback clause lead to payments?
Designed to return incentive fees to LPs when early profits are followed by subsequent losses.
What is the difference between a hard hurdle rate and a soft hurdle rate?
A hard hurdle rate limits incentive fees to profits in excess of the hurdle rate.
A soft hurdle rate allows fund managers to earn an incentive fee on all profits, given the hurdle rate has been achieved.
Simple Interest
Interest without compounding
Discrete Compounding
Includes any compounding interval other than continuous compounding such as daily, monthly, or annual.
Rate of Return formula:
Rate of return= (Change in Price + Cash Flows)/ Initial Price
IRR ( Internal Rate of Return)
Discount rate that equated the present value of the costs (cash outflows) of an investment withe present value of the benefits( cash inflows) from the investment.
Lifetime IRR
Contains all of the cash lows, realized or anitcipated, occuring
