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Investment Planning > Measures of Investment Returns > Flashcards

Measures of Investment Returns Flashcards

1
Q

What is the simple rate of return?

A

=total return (assets plus growth) / # yrs

Ignores the time value of money

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2
Q

What is the compound rate of return?

A

Either time value or uneven cash flow calculator functions

Assumes that growth is reinvested over time

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3
Q

What is the arithmetic mean of returns?

A

=the sum of each period’s returns / number of periods

Does not assume reinvestment or compounding of returns

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4
Q

What is the geometric mean of returns?

A

N=# periods
I/Yr= solve
PV= -($invested)
FV=(1 + r1)(1 + r2)…(1 + rn) **If negative return, then (1 - r1) OR total $ amount

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5
Q

What are time weighted returns?

A

Follows the initial/individual investment through time for total return. Does not account for any subsequent cash flows in or out of that investment.

CF0= -50 (initial investment)
CF1= $4 (dividend)
CF2=$75 (sale of the investment)
I/YR= solve

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6
Q

What are dollar-weighted returns?

A

Unlike time weighted returns, dollar weighted returns account for subsequent cash flows in and out

CF0= -$50 (initial investment)
CF1= -$61 ($4 dividend - purchase of $65 stock)
CF2= $150 (sale of two stocks)
IRR/YR = solve (x # of periods/yr)
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7
Q

What is the nominal rate of return?

A

The rate of return for a given period without accounting for inflation

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8
Q

What is the real rate of return?

A

The rate of return for a given period taking inflation into account.

=[(1 + Rn) / (1 + i) - 1] x 100

Rn = absolute return
i = inflation
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9
Q

What is the after-tax inflation-adjusted rate of return?

A

The reduces the overall rate of return by both inflation and taxes.

Step 1: reduce the real rate of return by the tax bracket. (rnominal x (1 - marg tax rate)

Step 2: replace numerator in real rate of return formula, with tax-adjusted rate

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10
Q

What is APR?

A

The yearly cost of funds expressed as a percentage. It does not take compounding into effect.

15% APR = 1.25% monthly APR

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11
Q

What is the effective annual rate (EAR)?

A

The EAR takes into account compounding the APR

EAR = [1 + (i / n)]^n - 1

i = interest
n = # periods
hint: ^n = [shift] X on calculator. Must enter # compounding periods after

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12
Q

What is total return?

A

Sum of dividends, interests, plus any capital appreciation.

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13
Q

What is the SEC yield?

A

Represents dividends and interest earned over a 30 day period which the SEC requires mutual funds to report to allow investors to compare funds

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14
Q

What is the holding period return (HPR)?

A

The total return of an investment for the given period that the investment is owned.

= ending value - beginning value +/- cash flows / beginning value

OR

= [(1 + r1)(1 +r2)…(1+rn)] - 1

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15
Q

What is the Jensen’s alpha?

A

On formula sheet

Alpha is an absolute value used to measure the actual portfolio performance against its expected performance

\+a = outperformed expectations
-a= underperformed expectations
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16
Q

What is the Sharpe’s ratio?

A

Pick the higher Sharpe’s ratio. If the portfolio Sharpe’s ratio is higher than the market Sharp’s ratio, then the portfolio manager has outperformed the market.

IMPORTANT: only use Sharpe’s ratio within the same asset class.
IMPORTANT: if R2 is less than 70%, you can’t use Jensen’s or Treynor’s; you must use Sharpe’s

17
Q

What is the Treynor ratio?

A

Pick the highest Treynor’s ratio

Treynor’s ratio measures a portfolio’s performance against its Beta or risk. In order to make that meaningful, it has to be compared to another portfolio or index.

18
Q

What is the risk adjusted return?

A

= nominal rate of return / either std dev OR beta

19
Q

What is CAPM?

A

Capital adjusted pricing model

20
Q

In the formula for Jensen’s alpha, Treynor’s and Sharpe’s ratios, what do the following symbols mean?

αp = 
βp  = 
  ̄r p  = 
 ̄r m = 
  ̄r f =
A

αp = alpha, which represents the return that is able to be earned above or below an unmanaged portfolio with identical market risk
βp = beta for Portfolio P (p)
̄r p = average rate of return for Portfolio P (p)
̄r m = market’s rate of return
̄r f = risk-free rate of return

21
Q

What is the information ratio?

A

Measures the active return over the active risk. In an actively managed portfolio, the manager will take risks to beat the market. The higher the IR, the more likely that the portfolio manager was able to capitalize on opportunities in the marketplace.

22
Q

When is Beta meaningful?

A

> 70%

23
Q

What is the acronym BATS?

A

B- beta >70%, use
A- alpha or
T- treynor
S- Sharpe if beta is <70%

24
Q

What is the difference between a price-weighted index and a market capitalization-weighted index?

A

Price-weighted: measures the average of stock prices to provide an index for an asset class.
Market cap weighted: measures the value of available companies (share price x # shares outstanding)

25
Q

What is a bond’s current yield?

A

It is the return represented by the amount of the annual interest income paid, in relation to the current market value of the bond

=annual interest / current market price

26
Q

What is a bond’s yield to maturity?

A

It is the total return earned on a bond that is held to maturity. It is assumed that all interest payments on the bond will be reinvested at the calculated YTM. The higher, the better

(2 periods per yr for semi-annual payments)
N = length of bond left
I/YR = solve
PV = price bond is trading for in secondary market (-)
PMT = coupon price (% of PAR / 2 for semi-annual payments)
FV = $1000 PAR

27
Q

What is a bond’s yield to call?

A

Takes into account that the bond may be called

Same as YTM inputs except:

N = years until call date
FV = call price
28
Q

What are the two situations when you should calculate a taxable equivalent yield (TEY)?

A
  1. When a municipal bond is free from federal income tax, but subject to state income tax
    - TEY formula on test sheet
  2. When a municipal bond is free from both federal and state income tax
    For itemized deductions: TEY= tax free equivalent yield / (1 - SMTB)(1 - FMTB)
    For non-itemized deductions: TEY= tax free equivalent yield / 1 - SMTB+FMTB)
29
Q

When using a security market index to represent a market’s performance, the performance of that market over time is best represented by

A) the percent change in the index value.
B) the change in the standard deviation of the index.
C) the index value.
D) the change in the index value.

A

A) the percent change in the index value.

Investment Planning (8 decks)

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