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The time-weighted return measures the:
 A) return on the average investment during the period.
 B) return per unit of domestic currency.
 C) total return during the period.

The time-weighted return measures the return per unit of domestic currency. The calculation involves taking a geometric average of the returns of the various sub-periods.
What is the major difference between the money-weighted and time-weighted rate of return? The money-weighted return:
 A) computes the return more precisely using the internal rate of return computation while time-weighted return computation is an approximation.
 B) penalizes managers for cash flows that occur outside of their control while the time-weighted return does not.
 C) is averaged across periods to arrive at an annual rate of return while the time-weighted return is compounded across periods to arrive at an annual rate of return.

The time-weighted return is computed every time a cash flow occurs, so it does not penalize managers for cash flows that occur outside of their control. The money-weighted return, on the other hand, is impacted by cash flows. Note that an approximation for different time periods can be made when using the time-weighted return, however, using an approximation would be at the discretion of the person calculating the return and is not part of the methodology behind the time-weighted return calculation.
For a global portfolio, the money-weighted returns for the four quarters of last year are: 3%, -2%, 5%, and 2.5%. The corresponding time-weighted returns are: 2.5%, -1%, 4%, and 3.5%. What would an investor report as the annual rate of return on the portfolio?
 A) 9.0%.
 B) 8.64%.
 C) 9.23%.

For reporting purposes, time weighted return is reported. Annual return = 1.025 × 0.99 × 1.04 × 1.035 − 1 = 0.0923 or 9.23%.
Which of the following least accurately characterizes the time-weighted return? The time-weighted return:
 A) can be expensive and error prone.
 B) is most appropriate for a manager who cannot control the timing of the cash flows in and out of the fund.
 C) is similar to the internal rate of return.

The time-weighted return is not similar to the internal rate of return. The money-weighted return is similar to the internal rate of return and is also known as the linked internal rate of return. The other responses accurately characterize the time-weighted return.
One limitation of the time-weighted return is the fact that it:
 A) requires the computation of the internal rate of return every time a cash flow occurs.
 B) requires computations every time a cash flow occurs.
 C) penalizes managers for cash flows that occur outside of their control.

The time-weighted return computation requires computation of return every time a cash flow occurs. One of the advantages of the time-weighted return is that passive benchmarks use the same calculation methodology which makes it comparable to passive benchmarks and other portfolio managers.
One limitation of the money-weighted return is the fact that it:
 A) computes the return independent of the cash flows.
 B) requires computations every time a cash flow occurs.
 C) penalizes managers for cash flows that occur outside of their control.

The money-weighted return computation penalizes managers for cash flows that occur outside of their control.
Accounts that contain illiquid assets present additional problems of accurately measuring return. Which of the following statements would NOT be regarded as a problem associated directly with illiquid assets?
 A) Account valuations use trade date accounting as opposed to settlement accounting.
 B) Matrix pricing is used.
 C) Assets are carried at the price of the last trade.

The use of trade date accounting is regarded to be a key feature of a good return measurement process. The other options are examples of the problems caused when illiquid assets are included in the account. Matrix pricing is using the quoted price of a similar asset as a proxy for the market value of thinly traded fixed income securities.
Which of the following would NOT be regarded to be a problem relating to the quality of data used in calculating rates of return?
 A) Account valuations include trade date accounting.
 B) Matrix pricing is used for some fixed income securities.
 C) When accounts contain illiquid assets, estimates or guesses are used in the calculation.

The use of trade date accounting would be regarded as a positive attribute of the account in the context of measuring returns. Trade date accounting is preferred to settlement date and the inclusion of accrued interest and dividends would be ideal. Matrix pricing is the use of estimated prices taken from quoted prices on securities with similar characteristics; this could clearly introduce inaccuracies in the measurement of returns.
Frank Belanger would like to calculate the rate of return for an illiquid asset. He states that he will use matrix pricing to obtain a substitute for the security’s current price. Which of the following most accurately describes matrix pricing? In matrix pricing, the analyst uses:
 A) the price from the last trade for the same security.
 B) an average of recent prices.
 C) dealer quotes for similar securities.

Matrix pricing is used when the asset is illiquid and a security price is not readily available. In matrix pricing, the analyst uses dealer quoted prices for similar securities.
Which of the following is the most appropriate method of calculating the manager’s active return? The manager’s active return is the:
 A) market return minus the benchmark return.
 B) portfolio return minus the benchmark return.
 C) portfolio return minus the market return.

The manager’s active return is the portfolio return minus the benchmark return, where the benchmark is appropriate to the manager’s style.
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