Quant - Rates & Returns Flashcards
What are three interpretations of an interest rate?
An interest rate, r, can have three interpretations:
(1) a required rate of return,
(2) a discount rate,
(3) an opportunity cost.
An interest rate reflects the relationship between differently dated cash flows.
How does an interest rate relate to the risk-free rate and other premiums?
An interest rate can be viewed as the sum of the real risk-free interest rate and a set of premiums that compensate lenders for bearing distinct types of risk.
What are the four types of premiums that usually make up an interest rates premium?
Remember “MILD”:
Maturity premium
Inflation premium
Liquidity premium
Default risk premium
How do you calculate the nominal risk-free interest rate?
The nominal risk-free interest rate is approximated as the sum of the real risk-free interest rate and the inflation premium.
What are the two components of an asset’s return?
(1) In income yield consisting of cash dividends or interest payments
(2) a return reflecting the capital gain or loss resulting from changes in the price of the financial asset
What is the “holding period return”?
How do you calculate it?
A holding period return, R, is the return that an investor earns for a single, specified period of time (e.g., one day, one month, five years).
Consider the following means for a dataset:
Arithmetic mean
Geometric mean
Harmonic mean
Trimmed mean
Winsorized mean
What drives the choice of which of the various alternative measurements of mean to use?
The choice of which of the various alternative measurements of mean to use for a given dataset depends on considerations such as:
(1) Presence of extreme outliers;
(2) Outliers that we want to include;
(3) Whether there is a symmetric distribution;
(4) Whether we want to capture the impact of compounding.
What is the purpose of the money-weighted return?
How do you calculate it?
Purpose:
The actual return earned on an investment after accounting for the value and timing of cash flows.
Calculation:
Use IRR on the calculator.
What does a time-weighted return measure?
How do you calculate it?
Whats the formula for N items in a dataset?
Purpose:
A time-weighted return measures the compound rate of growth of one unit of currency invested in a portfolio during a stated measurement period.
Calculated By:
Geometric Mean
Formula:
What is the benefit of Time-Weighted returns to Money-Weighted Returns?
Unlike a money-weighted return, a time-weighted return is not sensitive to the timing and amount of cashflows
Would a portfolio manager prefer a time-weighted return or money-weighted return?
Answer:
A time-weighted return.
Why?
Cash withdrawals or additions to the portfolio are generally outside of the control of the portfolio manager.
What is the benefit or purpose of annualizing periodic returns?
Annualizing periodic returns allows investors to compare different investments across different holding periods to better evaluate and compare their relative performance.
What equation is used to calculate the annualized periodic return?
see image
If given two returns with two different time horizons, how would you compare them.
Ex:
Option 1: 1% return / month for 8 months
Option 2: 0.50% return / week for 32 weeks (i.e., 8 months)
?
Calculate the annualized period return and compare results.
How do you calculate a manager’s “NET RETURN”?
The gross return less managerial and administrative expenses