1215

Which of the following statements about money-weighted and time-weighted returns is least accurate?

A) The money-weighted return applies the concept of internal rate of return to investment portfolios.

B) If the investment period is greater than one year, an analyst must use the geometric mean to calculate the annual time-weighted return.

C) If a client adds funds to an investment prior to an unfavorable market, the time-weighted return will be depressed.

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The time-weighted method is not affected by the timing of cash flows. The other statements are true.

1215

An investor buys four shares of stock for $50 per share. At the end of year one she sells two shares for $50 per share. At the end of year two she sells the two remaining shares for $80 each. The stock paid no dividend at the end of year one and a dividend of $5.00 per share at the end of year two. What is the difference between the time-weighted rate of return and the money-weighted rate of return?

A) 20.52%.

B) 9.86%.

C) 14.48%.

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T = 0: Purchase of four shares = -$200.00

T = 1: Dividend from four shares = +$0.00

Sale of two shares = +$100.00

T = 2: Dividend from two shares = +$10.00

Proceeds from selling shares = +$160.00

The money-weighted return is the rate that solves the equation:

$200.00 = $100.00 / (1 + r) + $170.00 / (1 + r)².

Cfo = -200, CF1 = 100, Cf2 = 170, CPT → IRR = 20.52%.

The holding period return in year one is ($50.00 ? $50.00 + $0.00) / $50.00 = 0.00%.

The holding period return in year two is ($80.00 ? $50.00 + $5.00) / $50 = 70.00%.

The time-weighted return is [(1 + 0.00)(1 + 0.70)]^1/2 ? 1 = 30.38%.

The difference between the two is 30.38% ? 20.52% = 9.86%.

1215

Which of the following is most accurate with respect to the relationship of the money-weighted return to the time-weighted return? If funds are contributed to a portfolio just prior to a period of favorable performance, the:

A) money-weighted rate of return will tend to be elevated.

B) time-weighted rate of return will tend to be elevated.

C) money-weighted rate of return will tend to be depressed.

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The time-weighted returns are what they are and will not be affected by cash inflows or outflows. The money-weighted return is susceptible to distortions resulting from cash inflows and outflows. The money-weighted return will be biased upward if the funds are invested just prior to a period of favorable performance and will be biased downward if funds are invested just prior to a period of relatively unfavorable performance. The opposite will be true for cash outflows.

1215

The money-weighted return also is known as the:

A) return on invested capital.

B) internal rate of return (IRR) of a portfolio.

C) measure of the compound rate of growth of $1 over a stated measurement period.

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It is the IRR of a portfolio, taking into account all of the cash inflows and outflows.

1215

Which of the following statements regarding the money-weighted and time-weighted rates of return is least accurate?

A) The money-weighted rate of return removes the effects of the timing of additions and withdrawals to a portfolio.

B) The time-weighted rate of return reflects the compound rate of growth of one unit of currency over a stated measurement period.

C) The time-weighted rate of return is the standard in the investment management industry.

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The money-weighted return is actually highly sensitive to the timing and amount of withdrawals and additions to a portfolio. The time-weighted return removes the effects of timing and amount of withdrawals to a portfolio and reflects the compound rate of growth of $1 over a stated measurement period. Because the time-weighted rate of return removes the effects of timing, it is the standard in the investment management industry.

1215

An analyst managed a portfolio for many years and then liquidated it. Computing the internal rate of return of the inflows and outflows of a portfolio would give the:

A) time-weighted return.

B) net present value.

C) money-weighted return.

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The money-weighted return is the internal rate of return on a portfolio that equates the present value of inflows and outflows over a period of time.