Module 52.1: Returns Measures

Question 1

What is the formula for holding period return? What if there are dividends?

Answer 1

without dividends: (end of period value / beginning period value) - 1

with dividends: [ (end of period value + dividends) / beginning value] - 1

Question 2

What is real return?

Answer 2

nominal return adjusted for inflation. if real return is 7%, and inflation is 2%, then real return is simply 7% - 2%.

Question 3

what is leveraged return?

Answer 3

refers to a return to an investor that is a multiple of the return on the underlying asset.

Question 4

What is the money-weighted return of a portfolio?

Answer 4

defined as the internal rate of return on a portfolio, taking into account all the cash inflows and outflows.

Step 1: detremine the timing of each cash flow and inflow

Step 2: net the cash flows for each time period and set the PV of cash inflows equal to PV of cash outflows

Step 3: calculate rate using IRR

Question 5

What is the time-weighted return of a portfolio?

Answer 5

measures compound growth of an investment portfolio.

Step 1: value the portfolio immediately preceding significant additions or withdrawals. Form subperiods over the evaluation period that correspond to the dates of deposits and withdrawals.

Step 2: Compute the holding period return (HPR) of the portfolio for each subperiod

Step 3: compute the product of (1+HPR) for each subperiod to obtain a total return for the entire measurement period.

Question 6

Why do investment managers prefer to use the time-weighted return of a portfolio rather than money-weighted?

Answer 6

time-weighted return will no be skewed by recent contributions into the portfolio before periods of positive and negative performance.