Rates and Returns Flashcards
(14 cards)
What does an interest rate represent in finance?
It can be interpreted as a required rate of return, a discount rate, or the opportunity cost of consumption.
What are the components of a nominal interest rate?
Real risk-free rate + inflation premium + default risk premium + liquidity premium + maturity risk premium.
What is the holding period return (HPR)?
The percentage change in value over a holding period, including income: (P1 - P0 + D) / P0
When should the arithmetic mean return be used?
To estimate expected returns when returns are independently and identically distributed (IID). *include all values and outliers
When should the geometric mean return be used?
To measure compound growth over multiple periods. (ex: calculate the compound annual rate of return)
What does the harmonic mean calculate in investing?
The average cost per share when investing equal dollar amounts periodically.
How do arithmetic, geometric, and harmonic means rank?
Arithmetic ≥ Geometric ≥ Harmonic (equality only when all observations are identical).
What is the money-weighted rate of return (MWRR)?
The internal rate of return (IRR) of a portfolio including all cash inflows and outflows.
What is the time-weighted rate of return (TWRR)?
The geometric mean of sub-period returns; it removes the effects of external cash flows. (Formula 1.1)
When should TWRR be used over MWRR?
When the manager does not control cash flows into/out of the portfolio.
What is a continuously compounded return?
ln(1 + HPR); additive over time.
What is gross return vs. net return?
Gross: Return before management + admin fees. (BUT AFTER TRADING FEES)
Net: Return after fees.
What is the real return?
Approx. nominal return - inflation rate; measures increase in purchasing power.
What is leveraged return?
Return on equity when using borrowed capital: greater upside/downside due to magnification.
