LOS 1.c

Question 1

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What an IRR and NPV

Answer 1

IRR = Internal Rate of Return - the discount rate that makes the present value of future cash flows equal to the initial investment, resulting in a net present value of zero
NPV - Net Present Value - the difference between the PV of future cash inflows and PV and cash outflows to see whether something is profitable

Question 2

What is the Money weighted rate of return, how to work it out, and what is it used for?

Answer 2

• Determine the timing of each cashflow and see whether it is an inflow or outflow
• Net the cashflows for each period and set a minus a plus - net it
• solve for R
• On the Calc: CF0 = Initial cash, C01 = period 1 CF, C02 = period 2 CF, IRR CPT

Question 3

What is the Time-weighted rate of return, how to work it out, and what is it used for?

Answer 3

• What is it: Measures compound growth and is the rate at which $1 compounds over a specifc performance horizon
• Calc: Value subperiods using dates of deposits + withdrawals, compute HPR of portfolio for each period, computer overall HPR for a total return. HPR = (Ending Value + Dividend / Purchase Value)
• Then (1+time weighted rate of return)^2 = (1+hpr)(1+hpr)

Question 4

What is the difference between time weighted rate of return and money weighted rate of return

Answer 4

Money-weighted returns are sensitive to the timing of cash flows. Contributions made just before poor performance lower the money-weighted return relative to the time-weighted return, while contributions before strong performance increase it. The time-weighted return eliminates this cash flow timing effect, offering a truer measure of investment skill. However, if the manager controls cash flows, the money-weighted return is more appropriate.