Level 1 – Discounted Cash flow Application – Time Weighted Return

Question

Hello - I have a question on this problem. I understand the steps. but, the curriculum show that the final step is an annualized return by taking the Geometric mean. They did not do that here in this question? so, when should i know to do the Geometric mean. i would have done it this way... ((1.24 * .10704 * 1.1250 * 0.96390)^1/4)-1. Thank you so much.Practice Q:The following table shows the cash flows for a particular portfolio:Amounts in USD Quarter 1 Quarter 2 Quarter 3 Quarter 4Beginning balance 2,000,000 3,100,000 3,800,000 4,500,000Beginning periodic inflow/(outflow) 500,000 450,000 200,000 (350,000)Beginning balance 2,500,000 3,550,000 4,000,000 4,150,000Ending balance 3,100,000 3,800,000 4,500,000 4,000,000Which of the following is most likely the annualized time weighted return of the portfolio ? A 43.93%. B 8.47%. C 9.50%.Explanation:A is correct. Calculate the holding period return for every period:HPR = P1 - Po + D1 / Po = Ending value - beginning value + Cash flow / beginning valueWhere:Po = initial InvestmentP1 = price received at the end of holding periodD1 = cash paid by the investment at the end of the holding periodSince the returns are for each quarter, we simply need to link the returns:1.24 * .10704 * 1.1250 * 0.9639 = 1.4393.The annualized time weighted return is equal to 43.93%.

guru987 · Answer

Cash flows are mentioned for four quarters, not four years. annualized return will be the total holding return for each period. No need of taking the mean.

fmccray · Answer

Thank you so much.