Investments: Measuring Return

Question 1

Holding Period Return

Answer 1

• not a compound rate of return.
• there is no consideration for the time an investment was held.
• Memorize equation as it is not provided on the exam

Question 2

Holding period Return Cont.

Answer 2

The examiners will typically not give you a straight holding period return because it is very straight forward.
Items that make the computation more difficult include:

Dividends received - make sure to add them to the numerator.

Margin interest paid - make sure to subtract from the numerator.

Taxes paid -

only do this if the question asks for the after-tax gain or loss. The taxes will be computed
based on the dividends received and any capital gains on the sale (short-term versus long-term). Taxes,
like margin interest, are subtracted from the numerator.

Purchased the securities on margin -

in the numerator make sure to subtract any interest paid. Also, in
the numerator you will include the total cost of the securities as a subtraction from the sales proceeds.
In the denominator you only include your equity in the trade.

Question 3

Holding Period calculation with cash flows

Question 4

Effective Annual Rate

Answer 4

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

Question 5

Effective Annual Rate - Example

Answer 5

Question 6

Arithmetic Average (mean)

Answer 6

• also known as the simple average, it is the sum of all numbers divided by the number of observations
• ignores compounding effect of returns over time.

Question 7

Geometric Average (geometric mean) - price of something

Answer 7

Question 8

Geometric Average (mean) - rate of return

Answer 8

• also a time weighted compounded rate of return.

- is the compounded rate of return.

Question 9

Weighted Average

Answer 9

• can be used to calculate a weighted average share price, expected returns, beta, or duration.
• the process is the same regardless of what is being calculated.

Question 10

Weighted Average Share price

Answer 10

-weighted average takes into account the number of shares of each various priced securities that are owned.

Question 11

Weighted Average Portfolio Return

Answer 11

Several factors must be taken into account:

1. Current market value of securities held.

2 the total portfolio value

3. The return of each security throughout the period in question.

Question 12

Weighted Average Portfolio Beta

Answer 12

Same as weighted average portfolio return

Question 13

Net Present Value (NPV)

Answer 13

• used to evaluate capital expenditures that will result in differing cash flows over the useful life or investment period.
• NPV is 0 or positive the investor would make the investment
• NPV is negative the investor would not make the investment

Question 14

Internal Rate of Return (IRR)

Answer 14

• discount rate that sets NPV formula equal to zero.
• used when you have uneven cash flows and you are asked to calculate compounded return.

If NPV is positive - IRR>Discount rate
If NPV is zero - IRR=Discount Rate
If NPV is negative - IRR

Question 15

Dollar-Weighted Return

Answer 15

• Calculate IRR using investors cash flows

- the method is the same

Question 16

Dollar Weighted Return

Answer 16

Calculate IRR using investors cash flows

Question 17

Time-weighted Return

Answer 17

• mutual funds report on time weighted basis (tested)
• calculates IRR using the securities cash flow.
• only concerned with the growth of a single share or single purchase.
• determined without regard to investors cash flow

Question 18

Arbitrage Pricing Theory (APT)

Answer 18

• asserts pricing imbalances cannot exist for any significant period of time; otherwise investors will exploit the price imbalance until the market prices are back to equilibrium.
• Multi factor model that attempts to explain return based on factors
• inputs are factors (F) such as inflation, risk premium and expected returns and their sensitivity (b) to those factors
• standard deviation and beta are not inputs variables to the APT.