Measuring Return (Lesson 3)

Question 1

What is the formula for holding period return

Answer 1

(SP - PP +- CF) / (PP or E)

SP = Selling price

PP= Purchase price

CF= Plus or Minus Cash Flow

E = Equity Invested

Question 2

Is holding period return a compounded rate of return

Answer 2

• No

Question 3

Does HPR consider time in the investment

Answer 3

• No

Question 4

How do you calculate HPR with the purchase of securities on margin

Answer 4

• In the numerator make sure to subtract any interest paid
• In the numerator include the total cost of the securities as a subtraction from sales proceeds
• In the denominator only include the equity in the trade

Question 5

What does the effective annual rate calculate

Answer 5

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

Question 6

What is the arithmetic average

Answer 6

• known as the simple average
• Ignores the compounding effect of returns over time

Question 7

What is the geometric average or geometric mean

Answer 7

• is the time weighted compounded rate of return

Question 8

What does weighted average take into account

Answer 8

• the number of shares of each of the various priced securities that are owned

Question 9

What factors must be taken into account in the process of calculating the weighted average of a portfolio return

Answer 9

• Current fair market value of the securities held
• total portfolio value
• return of each security throughout the period in question

Question 10

What does the NPV calculate

Answer 10

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

Question 11

Should an investor invest in an asset with a positive NPV

Answer 11

Yes

Question 12

Should an investor invest in an asset with a negative NPV

Answer 12

No

Question 13

Should an investor invest in an asset with a zero NPV

Answer 13

Yes

Question 14

What is the internal rate of return

Answer 14

• is the discount rate that sets the NPV formula equal to zero
• IRR can also be thought of as a compound rate of return

Question 15

How do you calculate the dollar weighted return

Answer 15

• it is just the IRR of return calculation with the CFJ keys

Question 16

What is the time weighted return

Answer 16

• Calculates IRR using the securities cash flow and assumes a buy and hold
• determined without the regard to the investors cash flows

Question 17

What type of return do mutual funds report on

Answer 17

• Time weighted basis

Question 18

What does the Arbitrage pricing theory assert

Answer 18

• that pricing imbalances cannot exist for any significant period of time otherwise investors will exploit the price imbalances until the market prices are back to equilibrium

Question 19

What type of model is the Arbitrage pricing theory and what does it attempt to do

Answer 19

• multifactor model that attempts to explain return based on facts
• Anytime a fact has a value of zero then that factor has no impact on return

Question 20

What does the arbitrage pricing theory look to take advantage of

Answer 20

• pricing imbalances

Question 21

What factors does the arbitrage pricing theory use

Answer 21

• inflation, risk premiums, and expected return and their sensitivity to those factors

Question 22

Does the arbitrage pricing theory us beta or standard deviation

Answer 22

• neither

Question 23

What are the steps to solve the problem of a client purchasing an asset in a foreign currency

Answer 23

• Covert US dollar to the foreign currency to determine the cost
• Compute the return typically utilizing holding period return calculations
• Convert the foreign currency back to US dollar