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TestID:7658688DiscountedCashFlowApplications
Question#1of72 QuestionID:412839
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Question#2of72 QuestionID:412885
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Question#3of72 QuestionID:412834
Inordertocalculatethenetpresentvalue(NPV)ofaproject,ananalystwouldleastlikelyneedtoknowthe:
internalrateofreturn(IRR)oftheproject.
opportunitycostofcapitalfortheproject.
timingoftheexpectedcashflowsfromtheproject.
Explanation
TheNPViscalculatedusingtheopportunitycost,discountrate,expectedcashflows,andtimingoftheexpectedcashflowsfromtheproject.Theproject'sIRRisnotusedtocalculatetheNPV.
ATreasurybill(Tbill)withafacevalueof$10,000and219daysuntilmaturityissellingfor97.375%offacevalue.WhichofthefollowingisclosesttotheholdingperiodyieldontheTbillifhelduntilmaturity?
2.81%.
2.70%.
2.63%.
Explanation
Theformulaforholdingperiodyieldis:(P P +D )/(P ),whereD foraTbilliszero(itdoesnothaveacoupon).Therefore,theHPYis:($10,000$9,737.50)/($9,737.50)=0.0270=2.70%.
Alternatively(100/97.375)1=0.02696.
CalabashCrabHouseisconsideringaninvestmentinmutuallyexclusivekitchenupgradeprojectswiththefollowingcashflows:
ProjectA ProjectBInitialYear $10,000 $9,000
Year1 2,000 200Year2 5,000 2,000Year3 8,000 11,000Year4 8,000 15,000
AssumingCalabashhasa12.5%costofcapital,whichofthefollowinginvestmentdecisionsismostappropriate?
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Question#4of72 QuestionID:412869
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AcceptProjectAbecauseitsinternalrateofreturnishigherthanthatofProjectB.
Acceptbothprojectsbecausetheybothhavepositivenetpresentvalues.
AcceptProjectBbecauseitsnetpresentvalueishigherthanthatofProjectA.
Explanation
Whennetpresentvalue(NPV)andinternalrateofreturn(IRR)giveconflictingprojectrankings,NPVisthemostappropriatemethodfordecidingbetweenmutuallyexclusiveprojects.Here,theNPVofprojectAis$6,341andtheNPVofProjectBis$6,688.BothNPVsarepositive,soCalabashshouldselecttheProjectBbecauseofitshigherNPV.
Assumeaninvestormakesthefollowinginvestments:
Today,shepurchasesashareofstockinRedwoodAlternativesfor$50.00.Afteroneyear,shepurchasesanadditionalsharefor$75.00.Afteronemoreyear,shesellsbothsharesfor$100.00each.
Therearenotransactioncostsortaxes.Theinvestor'srequiredreturnis35.0%.
Duringyearone,thestockpaida$5.00persharedividend.Inyeartwo,thestockpaida$7.50persharedividend.
Thetimeweightedreturnis:
51.7%.
51.4%.
23.2%.
Explanation
Tocalculatethetimeweightedreturn:
Step1:Separatethetimeperiodsintoholdingperiodsandcalculatethereturnoverthatperiod:
Holdingperiod1:P =$50.00
D =$5.00
P =$75.00(frominformationonsecondstockpurchase)
HPR =(7550+5)/50=0.60,or60%
Holdingperiod2:P =$75.00
D =$7.50
P =$100.00
HPR =(10075+7.50)/75=0.433,or43.3%.
Step2:Usethegeometricmeantocalculatethereturnoverbothperiods
Return=[(1+HPR )(1+HPR )] 1=[(1.60)(1.433)] 1=0.5142,or51.4%.
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1 2 1/2 1/2
Question#5of72 QuestionID:412891
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Question#6of72 QuestionID:412864
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Question#7of72 QuestionID:412836
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ATreasurybillwithafacevalueof$1,000,000and45daysuntilmaturityissellingfor$987,000.TheTreasurybill'sbankdiscountyieldisclosestto:
7.90%.
10.40%.
10.54%.
Explanation
Theactualdiscountis1.3%,1.3%(360/45)=10.4%
Thebankdiscountyieldiscomputedbythefollowingformula,r=(dollardiscount/facevalue)(360/numberofdaysuntilmaturity)=[(1,000,000987,000)/(1,000,000)](360/45)=10.40%.
Ananalystmanagedaportfolioformanyyearsandthenliquidatedit.Computingtheinternalrateofreturnoftheinflowsandoutflowsofaportfoliowouldgivethe:
timeweightedreturn.
netpresentvalue.
moneyweightedreturn.
Explanation
Themoneyweightedreturnistheinternalrateofreturnonaportfoliothatequatesthepresentvalueofinflowsandoutflowsoveraperiodoftime.
Fisher,Inc.,isevaluatingthebenefitsofinvestinginanewindustrialprinter.Theprinterwillcost$28,000andincreaseaftertaxcashflowsby$8,000duringeachofthenextfiveyears.Whataretherespectiveinternalrateofreturn(IRR)andnetpresentvalue(NPV)oftheprinterprojectifFisher'srequiredrateofreturnis11%?
5.56%$3,180.
17.97%$5,844.
13.20%$1,567.
Explanation
IRRKeystrokes:CF =$28,000CF =$8,000F =5CPTIRR=13.2%.
NPVKeystrokes:CF =$28,000CF =$8,000F =5I=11CPTNPV=1,567.
Sincecashflowsarelevel,analternativeis:IRR:N=5PMT=8,000PV=28,000CPTI/Y=13.2%.
0 1 1
0 1 1
Question#8of72 QuestionID:412861
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Question#9of72 QuestionID:412894
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Question#10of72 QuestionID:412874
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NPV:I/Y=11CPTPV=29,567+28,000=1,567
Aninvestorexpectsastockcurrentlysellingfor$20persharetoincreaseto$25byyearend.Thedividendlastyearwas$1butheexpectsthisyear'sdividendtobe$1.25.Whatistheexpectedholdingperiodreturnonthisstock?
31.25%.
28.50%.
24.00%.
Explanation
Return=[dividend+(endbegin)]/beginningprice
R=[1.25+(2520)]/20=6.25/20=0.3125
ATreasurybillhas90daysuntilitsmaturityandaholdingperiodyieldof3.17%.Itseffectiveannualyieldisclosestto:
13.49%.
12.68%.
13.30%.
Explanation
Theeffectiveannualyield(EAY)isequaltotheannualizedholdingperiodyield(HPY)basedona365dayyear.EAY=(1+HPY) 1=(1.0317) 1=13.49%.
Aninvestormakesthefollowinginvestments:
Shepurchasesashareofstockfor$50.00.
Afteroneyear,shepurchasesanadditionalsharefor$75.00.
Afteronemoreyear,shesellsbothsharesfor$100.00each.
Therearenotransactioncostsortaxes.
Duringyearone,thestockpaida$5.00persharedividend.Inyear2,thestockpaida$7.50persharedividend.Theinvestor'srequired
returnis35%.Hermoneyweightedreturnisclosestto:
7.5%.
48.9%.
16.1%.
365/t 365/90
Question#11of72 QuestionID:412893
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Question#12of72 QuestionID:412868
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Question#13of72 QuestionID:412877
Explanation
Todeterminethemoneyweightedrateofreturn,useyourcalculator'scashflowandIRRfunctions.Thecashflowsareasfollows:
CF0:initialcashoutflowforpurchase=$50
CF1:dividendinflowof$5cashoutflowforadditionalpurchaseof$75=netcashoutflowof$70
CF2:dividendinflow(2$7.50=$15)+cashinflowfromsale(2$100=$200)=netcashinflowof$215
EnterthecashflowsandcomputeIRR:
CF0=50CF1=70CF2=+215CPTIRR=48.8607
ATreasurybill,with45daysuntilmaturity,hasaneffectiveannualyieldof12.50%.Thebill'sholdingperiodyieldisclosestto:
1.57%.
1.46%.
1.54%.
Explanation
Theeffectiveannualyield(EAY)isequaltotheannualizedholdingperiodyield(HPY)basedona365dayyear.EAY=(1+HPY) 1.HPY=(EAY+1) 1=(1.125) 1=1.46%.
OnJanuary1,JonathanWoodinvests$50,000.AttheendofMarch,hisinvestmentisworth$51,000.OnApril1,Wooddeposits$10,000intohisaccount,andbytheendofJune,hisaccountisworth$60,000.Woodwithdraws$30,000onJuly1andmakesnoadditionaldepositsorwithdrawalstherestoftheyear.Bytheendoftheyear,hisaccountisworth$33,000.Thetimeweightedreturnfortheyearisclosestto:
10.4%.
7.0%.
5.5%.
Explanation
JanuaryMarchreturn=51,000/50,0001=2.00%AprilJunereturn=60,000/(51,000+10,000)1=1.64%JulyDecemberreturn=33,000/(60,00030,000)1=10.00%Timeweightedreturn=[(1+0.02)(10.0164)(1+0.10)]1=0.1036or10.36%
Aninvestorbuysoneshareofstockfor$100.Attheendofyearoneshebuysthreemoresharesat$89pershare.Attheendofyeartwoshesellsallfoursharesfor$98each.Thestockpaidadividendof$1.00pershareattheendofyearoneand
365/t t/365 45/365
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Question#14of72 QuestionID:412854
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Question#15of72 QuestionID:412848
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Question#16of72 QuestionID:412882
yeartwo.Whatistheinvestor'stimeweightedrateofreturn?
6.35%.
11.24%.
0.06%.
Explanation
Theholdingperiodreturninyearoneis($89.00$100.00+$1.00)/$100.00=10.00%.
Theholdingperiodreturninyeartwois($98.00$89.00+$1.00)/$89=11.24%.
Thetimeweightedreturnis[{1+(0.1000)}{1+0.1124}] 1=0.06%.
Astockiscurrentlyworth$75.Ifthestockwaspurchasedoneyearagofor$60,andthestockpaida$1.50dividendoverthecourseoftheyear,whatistheholdingperiodreturn?
27.5%.
22.0%.
24.0%.
Explanation
(7560+1.50)/60=27.5%.
Whichofthefollowingisleastlikelyaproblemassociatedwiththeinternalrateofreturn(IRR)methodformakinginvestmentdecisions?
TheIRRmethoddeterminesthediscountratethatsetsthenetpresentvalueofaprojectequaltozero.
Aninvestmentprojectmayhavemorethanoneinternalrateofreturn.
IRRandNPVcriteriacangiveconflictingdecisionsformutuallyexclusiveprojects.
Explanation
TheIRRmethodequatesaninvestment'spresentvalueofinflowstoitspresentvalueofoutflows.TheIRRbydefinitionisthediscountratethatsetsthenetpresentvalueofaprojectequaltozero.Therefore,thedecisionruleforindependentprojectsisasfollows:iftheIRRisabovethefirm'scostofcapital,theprojectshouldbeaccepted,andiftheIRRisbelowthecostofcapital,theprojectshouldberejected.
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Question#17of72 QuestionID:412903
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Question#18of72 QuestionID:412835
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ATreasurybillhas40daystomaturity,aparvalueof$10,000,andwasjustpurchasedbyaninvestorfor$9,900.Itsholdingperiodyieldisclosestto:
1.00%.
1.01%.
9.00%.
Explanation
Theholdingperiodyieldisthereturnthattheinvestorwillearnifthebillishelduntilitmatures.Theholdingperiodyieldformulais(pricereceivedatmaturityinitialprice+interestpayments)/(initialprice)=(10,0009,900+0)/(9,900)=1.01%.RecallthatwhenbuyingaTbill,investorspaythefacevaluelessthediscountandreceivethefacevalueatmaturity.
Theeffectiveannualyield(EAY)foraTbillmaturingin150daysis5.04%.Whataretheholdingperiodyield(HPY)andmoneymarketyield(MMY)respectively?
2.04%4.90%.
2.80%5.41%.
5.25%2.04%.
Explanation
TheEAYtakestheholdingperiodyieldandannualizesitbasedona365dayyearaccountingforcompounding.TheHPY=(1+0.0504) =1.20411=2.04%.UsingtheHPYtocomputethemoneymarketyield=HPY(360/t)=0.0204(360/150)=0.04896=4.90%.
ThefinancialmanageratGenesisCompanyislookingintothepurchaseofanapartmentcomplexfor$550,000.Netaftertaxcashflowsareexpectedtobe$65,000foreachofthenextfiveyears,thendropto$50,000forfouryears.Genesis'requiredrateofreturnis9%onprojectsofthisnature.Afternineyears,GenesisCompanyexpectstosellthepropertyforaftertaxproceedsof$300,000.Whatistherespectiveinternalrateofreturn(IRR)andnetpresentvalue(NPV)onthisproject?
6.66%$64,170.
7.01%$53,765.
13.99%$166,177.
Explanation
IRRKeystrokes:CF =$550,000CF =$65,000F =5CF =$50,000F =3CF =$350,000F =1.
NPVKeystrokes:CF =$550,000CF =$65,000F =5CF =$50,000F =3CF =$350,000F =1.
ComputeNPV,I=9.
150/365
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0 1 1 2 2 3 3
Question#19of72 QuestionID:412870
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Question#20of72 QuestionID:412873
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Note:Althoughtherateofreturnispositive,theIRRislessthantherequiredrateof9%.Hence,theNPVisnegative.
Aninvestorbuysashareofstockfor$200.00attimet=0.Attimet=1,theinvestorbuysanadditionalsharefor$225.00.Attimet=2theinvestorsellsbothsharesfor$235.00.Duringbothyears,thestockpaidapersharedividendof$5.00.Whataretheapproximatetimeweightedandmoneyweightedreturnsrespectively?
10.8%9.4%.
7.7%7.7%.
9.0%15.0%.
Explanation
Timeweightedreturn=(225+5200)/200=15%(470+10450)/450=6.67%[(1.15)(1.0667)] 1=10.8%
Moneyweightedreturn:200+[225/(1+return)]=[5/(1+return)]+[480/(1+return) ]moneyreturn=approximately9.4%
Notethattheeasiestwaytosolveforthemoneyweightedreturnistosetuptheequationandplugintheanswerchoicestofindthediscountratethatmakesoutflowsequaltoinflows.
Usingthefinancialcalculatorstocalculatethemoneyweightedreturn:(Thefollowingkeystrokesassumethatthefinancialmemoryregistersareclearedofpriorwork.)
TIBusinessAnalystIIPlus
EnterCF :200,+/,Enter,downarrowEnterCF :220,+/,Enter,downarrow,downarrowEnterCF :480,Enter,downarrow,downarrow,ComputeIRR:IRR,CPTResult:9.39
HP12C
EnterCF :200,CHS,g,CFEnterCF :220,CHS,g,CFEnterCF :480,g,CF ComputeIRR:f,IRRResult:9.39
Whichofthefollowingstatementsaboutmoneyweightedandtimeweightedreturnsisleastaccurate?
Themoneyweightedreturnappliestheconceptofinternalrateofreturntoinvestmentportfolios.
Ifaclientaddsfundstoaninvestmentpriortoanunfavorablemarket,thetimeweightedreturnwillbedepressed.
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Question#21of72 QuestionID:412871
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Question#22of72 QuestionID:412837
Iftheinvestmentperiodisgreaterthanoneyear,ananalystmustusethegeometricmeantocalculatetheannualtimeweightedreturn.
Explanation
Thetimeweightedmethodisnotaffectedbythetimingofcashflows.Theotherstatementsaretrue.
MirandaCromwell,CFA,buys2,000worthofSmith&JonesPLCsharesatthebeginningofeachyearforfouryearsatpricesof100,120,150and130respectively.AttheendofthefourthyearthepriceofSmith&JonesPLCis140.Thesharesdonotpayadividend.Cromwellcalculatesheraveragecostpershareas[(100+120+150+130)/4]=125.Cromwellthenusesthegeometricmeanofannualholdingperiodreturnstoconcludethathertimeweightedannualrateofreturnis8.8%.HasCromwellcorrectlydeterminedheraveragecostpershareandtimeweightedrateofreturn?
AveragecostTimeweightedreturn
Incorrect Correct
Correct Incorrect
Correct Correct
Explanation
BecauseCromwellpurchasesshareseachyearforthesameamountofmoney,sheshouldcalculatetheaveragecostpershareusingtheharmonicmean.Cromwelliscorrecttousethegeometricmeantocalculatethetimeweightedrateofreturn.Thecalculationisasfollows:
Year Beginningprice EndingpriceAnnualrateof
return
1 100 120 20%
2 120 150 25%
3 150 130 13.33%
4 130 140 7.69%
TWR=[(1.20)(1.25)(0.8667)(1.0769)] 1=8.78%.Or,moresimply,(140/100) 1=8.78%.
Theestimatedannualaftertaxcashflowsofaproposedinvestmentareshownbelow:
Year1:$10,000
Year2:$15,000
Year3:$18,000
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Question#23of72 QuestionID:412857
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Question#24of72 QuestionID:412862
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Aftertaxcashflowfromsaleofinvestmentattheendofyear3is$120,000
Theinitialcostoftheinvestmentis$100,000,andtherequiredrateofreturnis12%.Thenetpresentvalue(NPV)oftheprojectisclosestto:
$63,000.
$66,301.
$19,113.
Explanation
10,000/1.12=8,929
15,000/(1.12) =11,958
138,000/(1.12) =98,226
NPV=8,929+11,958+98,226100,000=$19,113
Alternatively:CFO=100,000CF1=10,000CF2=15,000CF3=138,000I=12CPTNPV=$19,112.
Abondthatpays$100ininteresteachyearwaspurchasedatthebeginningoftheyearfor$1,050andsoldattheendoftheyearfor$1,100.Aninvestor'sholdingperiodreturnis:
10.5%.
10.0%.
14.3%.
Explanation
Inputintoyourcalculator:N=1FV=1,100PMT=100PV=1,050CPTI/Y=14.29
Whyisthetimeweightedrateofreturnthepreferredmethodofperformancemeasurement?
Thereisnopreferencefortimeweightedversusmoneyweighted.
Timeweightedreturnsarenotinfluencedbythetimingofcashflows.
Timeweightedallowsforinterperiodmeasurementandthereforeismoreflexiblein
determiningexactlyhowaportfolioperformedduringaspecificintervaloftime.
Explanation
Moneyweightedreturnsaresensitivetothetimingorrecognitionofcashflowswhiletimeweightedratesofreturnarenot.
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Question#25of72 QuestionID:485757
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Question#26of72 QuestionID:412838
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Aninvestorstartedtheyearwitha$10,000portfolio.Hemadea$1,000contributionattheendofthefirstquarter,a$2,000withdrawalattheendofthethirdquarter,andendedtheyearwithaportfoliovalueof$10,553.Thequarterlyholdingperiodreturnsfortheinvestor'sportfolioareasfollows.
Q1 Q2 Q3 Q4
3% 5% 8% 10%
Theeffectiveannualmoneyweightedandtimeweightedreturnsareclosestto:
Moneyweighted
Timeweighted
15.13% 3.84%
3.59% 16.25%
15.13% 16.25%
Explanation
ThemoneyweightedreturnissimplytheIRR.TocalculatethequarterlyIRRfortheportfolio,usethecashflowfunctionsofthefinancialcalculator.Cashinflowsareinputasnegativenumbersandcashoutflowsarepositivenumbers.Thevalueoftheportfolioattheendoftheyearisconsideredacashoutflowbecausethatistheamountyoucouldpotentiallywithdrawifyouliquidatedtheportfolio.
CF0=10,000CF1=1,000CF2=2,000CF3=10,553CPTIRR=3.5856%.ThisistheperiodicIRR(quarterly).Theeffectiveannualreturnis(1+0.035856) 1=15.13%.
Thetimeweightedreturnisthegeometricallylinkedsubperiodreturns:(1.03)(0.95)(1.08)(1.10)1=16.25%.
Aninvestmentwithacostof$5,000isexpectedtohavecashinflowsof$3,000inyear1,and$4,000inyear2.Theinternalrateofreturn(IRR)forthisinvestmentisclosestto:
30%.
25%.
15%.
Explanation
TheIRRisthediscountratethatmakesthenetpresentvalueoftheinvestmentequalto0.
Thismeans$5,000+$3,000/(1+IRR)+$4,000/(1+IRR) =0
OnewaytocomputethisproblemistousetrialanderrorwiththeexistinganswerchoicesandchoosethediscountratethatmakesthePVofthecashflowsclosestto5,000.
$3,000/(1.25)+$4,000/(1.25) =4,960.
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Question#27of72 QuestionID:412888
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Question#28of72 QuestionID:412866
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Question#29of72 QuestionID:412856
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Alternatively:CFO=5,000CF1=3,000CF2=4,000CPTIRR=24.3%.
ATbillwithafacevalueof$100,000and140daysuntilmaturityissellingfor$98,000.Whatisthemoneymarketyield?
5.25%.
2.04%.
5.41%.
Explanation
Themoneymarketyieldisequivalenttotheholdingperiodyieldannualizedbasedona360dayyear.=(2,000/98,000)(360/140)=0.0525,or5.25%.
Themoneyweightedreturnalsoisknownasthe:
measureofthecompoundrateofgrowthof$1overastatedmeasurementperiod.
internalrateofreturn(IRR)ofaportfolio.
returnoninvestedcapital.
Explanation
ItistheIRRofaportfolio,takingintoaccountallofthecashinflowsandoutflows.
WhenAnnetteFamiglettihearsthatabaseballlovingfriendiscomingtovisit,shepurchasestwopremiumseatingticketsfor$45perticketforaneveninggame.Asthedateofthegameapproaches,Famigletti'sfriendtelephonesandsaysthathistriphasbeencancelled.FortunatelyforFamigletti,theticketssheholdsareinhighdemandasthereischancethattheleadingMajorLeagueBaseballhitterwillbreakthehomerunrecordduringthegame.Seeinganopportunitytoearnahighreturn,Famiglettiputstheticketsupforsaleonaninternetsite.Theauctionclosesat$150perticket.Afterpayinga10%commissiontothesite(ontheamountofthesale)andpaying$8totalinshippingcosts,Familgletti'sholdingperiodreturnisapproximately:
182%.
202%.
191%.
Explanation
Theholdingperiodreturniscalculatedas:(endingpricebeginningprice+/anycashflows)/beginningprice.Here,thebeginningandendingpricesaregiven.Theothercashflowsconsistofthecommissionof$30(0.101502tickets)andthe
Question#30of72 QuestionID:412895
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Question#31of72 QuestionID:412845
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Question#32of72 QuestionID:412851
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shippingcostof$8(totalforbothtickets).Thus,herholdingperiodreturnis:(2150245308)/(245)=1.91,orapproximately191%.
WhatistheeffectiveannualyieldofaTbillthathasamoneymarketyieldof5.665%and255daystomaturity?
4.01%.
5.92%.
5.79%.
Explanation
HoldingPeriodYield=4.0127%=5.665%(255/360)
EffectiveAnnualYield=(1.040127) =1.05711=5.79%.
Whichofthefollowingstatementsregardingmakinginvestmentdecisionsusingnetpresentvalue(NPV)andinternalrateofreturn(IRR)isleastaccurate?
Iftwoprojectsaremutuallyexclusive,oneshouldalwayschoosetheprojectwiththehighestIRR.
ProjectswithapositiveNPVsincreaseshareholderwealth.
IfafirmundertakesazeroNPVproject,thefirmwillgetlarger,butshareholderwealthwillnotchange.
Explanation
Iftwoprojectsaremutuallyexclusive,thefirmshouldalwayschoosetheprojectwiththehighestNPVratherthanthehighestIRR.Iftwoprojectsaremutuallyexclusive,thefirmmayonlychooseone.ItispossibleforNPVandIRRtogiveconflictingdecisionsforprojectsofdifferentsizes.BecauseNPVisadirectmeasureofthechangeinshareholderwealth,NPVcriteriashouldbeusedwhenNPVandIRRdecisionsconflict.
WhenaprojecthasapositiveNPV,itwilladdtoshareholderwealthbecausetheprojectisearningmorethantheopportunitycostofcapitalneededtoundertaketheproject.IfafirmtakesonazeroNPVproject,thefirmwillearnexactlyenoughtocovertheopportunitycostofcapital.Thefirmwillincreaseinsizebytakingtheproject,butshareholderwealthwillnotchange.
Theinternalrateofreturn(IRR)methodandnetpresentvalue(NPV)methodofprojectselectionwillalwaysprovidethesameacceptorrejectdecisionwhen:
upfrontprojectcostsareunder$1.0million.
theprojectsaremutuallyexclusive.
365/255
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Question#33of72 QuestionID:412887
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Question#34of72 QuestionID:412863
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Question#35of72 QuestionID:412883
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theprojectsareindependent.
Explanation
Ifaproject'sIRRexceedsthecostofcapital,theproject'sNPVwillbepositive.TheonlywayinwhichacceptingapositiveNPVprojectwouldreducefirmvalueisifitsselectionprecludesselectionofaprojectthatwouldhaveenhancedfirmvaluetoagreaterextent(i.e.,hadahigherNPV).IRRandNPVmethodaccuracydonotdependuponprojectdurationorcosts.
ATbillwithafacevalueof$100,000and140daysuntilmaturityissellingfor$98,000.Whatisitsholdingperiodyield?
2.04%.
5.14%.
5.25%.
Explanation
TheholdingperiodyieldisthereturntheinvestorwillearniftheTbillisheldtomaturity.HPY=(100,00098,000)/98,000=0.0204,or2.04%.
Timeweightedreturnsareusedbytheinvestmentmanagementindustrybecausethey:
takeallcashinflowsandoutflowsintoaccountusingtheinternalrateofreturn.
resultinhigherreturnsversusthemoneyweightedreturncalculation.
arenotaffectedbythetimingofcashflows.
Explanation
Timeweightedreturnsarenotaffectedbythetimingofcashflows.Moneyweightedreturns,bycontrast,willbehigherwhenfundsare
addedatafavorableinvestmentperiodorwillbelowerwhenfundsareaddedduringanunfavorableperiod.Thus,timeweightedreturns
offerabetterperformancemeasurebecausetheyarenotaffectedbythetimingofflowsintoandoutoftheaccount.
ATreasurybill(Tbill)with38daysuntilmaturityhasabankdiscountyieldof3.82%.WhichofthefollowingisclosesttothemoneymarketyieldontheTbill?
3.81%.
3.87%.
3.84%.
Explanation
Question#36of72 QuestionID:412889
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Question#37of72 QuestionID:412853
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Question#38of72 QuestionID:412844
Theformulaforthemoneymarketyieldis:[360bankdiscountyield]/[360(tbankdiscountyield)].Therefore,themoneymarketyieldis:[3600.0382]/[360(380.0382)]=(13.752)/(358.548)=0.0384,or3.84%.
Alternatively:Actualdiscount=3.82%(38/360)=0.4032%.
TBillprice=1000.4032=99.5968%.
HPR=(100/99.5968)1=0.4048%.
MMY=0.4048%(360/38)=3.835%.
ATbillwithafacevalueof$100,000and140daysuntilmaturityissellingfor$98,000.Whatistheeffectiveannualyield(EAY)?
2.04%.
5.41%.
5.14%.
Explanation
TheEAYtakestheholdingperiodyieldandannualizesitbasedona365dayyearaccountingforcompounding.HPY=(100,00098,000)/98,000=0.0204.EAY=(1+HPY) 1=(1.0204) 1=0.05406=5.41%.
Ifaninvestorboughtastockfor$32andsolditoneyearlaterfor$37.50afterreceiving$2individends,whatwastheholdingperiodreturnonthisinvestment?
6.25%.
23.44%.
17.19%.
Explanation
HPR=[D+EndPriceBegPrice]/BegPrice
HPR=[2+37.5032]/32=0.2344.
WilliamsWarehousingcurrentlyhasawarehouseleasethatcallsforfiveannualpaymentsof$120,000.Thewarehouseowner,whoneedscash,isofferingWilliamsadealwhereinWilliamswillpay$200,000thisyearandthenpayonly$80,000eachoftheremaining4years.(Assumethatallleasepaymentsaremadeatthebeginningoftheyear.)ShouldWilliamsWarehousingaccepttheofferifitsrequiredrateofreturnis9%,andwhy?
365/t 365/140
A)
B)
C)
Question#39of72 QuestionID:412846
A)
B)
C)
Question#40of72 QuestionID:412904
A)
B)
C)
Yes,thereisasavingsof$45,494inpresentvalueterms.
No,thereisanadditional$80,000paymentinthisyear.
Yes,thereisasavingsof$49,589inpresentvalueterms.
Explanation
Thepresentvalueofthecurrentleaseis$508,766.38,whilethepresentvalueoftheleasebeingofferedis$459,177.59asavingsof49,589.Alternatively,thepresentvalueoftheextra$40,000atthebeginningofeachofthenext4yearsis$129,589whichis$49,589morethantheextra$80,000addedtothepaymenttoday.
JackSmith,CFA,isanalyzingindependentinvestmentprojectsXandY.Smithhascalculatedthenetpresentvalue(NPV)andinternalrateofreturn(IRR)foreachproject:
ProjectX:NPV=$250IRR=15%
ProjectY:NPV=$5,000IRR=8%
Smithshouldmakewhichofthefollowingrecommendationsconcerningthetwoprojects?
AcceptProjectYonly.
AcceptProjectXonly.
Acceptbothprojects.
Explanation
Theprojectsareindependent,meaningthateitheroneorbothprojectsmaybechosen.BothprojectshavepositiveNPVs,thereforebothprojectsaddtoshareholderwealthandbothprojectsshouldbeaccepted.
AninvestorhasjustpurchasedaTreasurybillfor$99,400.Ifthesecuritymaturesin40daysandhasaholdingperiodyieldof0.604%,whatisitsmoneymarketyield?
5.650%.
5.436%.
5.512%.
Explanation
Themoneymarketyieldistheannualizedyieldonthebasisofa360dayyearanddoesnottakeintoaccounttheeffectofcompounding.Themoneymarketyield=(holdingperiodyield)(360/numberofdaysuntilmaturity)=(0.604%)(360/40)=5.436%.
Question#41of72 QuestionID:412860
A)
B)
C)
Question#42of72 QuestionID:412884
A)
B)
C)
Question#43of72 QuestionID:412840
A)
B)
C)
AninvestorisconsideringinvestinginTawariCompanyforoneyear.Heexpectstoreceive$2individendsovertheyearandfeelshecansellthestockfor$30attheendoftheyear.Torealizeareturnontheinvestmentovertheyearof14%,thepricetheinvestorwouldpayforthestocktodayisclosestto:
$29.
$28.
$32.
Explanation
HPR=[Dividend+(EndingpriceBeginningprice)]/Beginningprice
0.14=[2+(30P)]/P
1.14P=32soP=$28.07
ATreasurybill(Tbill)withafacevalueof$10,000and44daysuntilmaturityhasaholdingperiodyieldof1.1247%.WhichofthefollowingisclosesttotheeffectiveannualyieldontheTbill?
12.47%.
8.76%.
9.72%.
Explanation
Theformulafortheeffectiveannualyieldis:((1+HPY) )1.Therefore,theEAYis:((1.011247) )1=0.0972,or9.72%
ThecapitalbudgetingdirectorofGreenManufacturingisevaluatingalaserimagingprojectwiththefollowingcharacteristics:Cost:$150,000Expectedlife:3yearsAftertaxcashflows:$60,317peryearSalvagevalue:$0
IfGreenManufacturing'scostofcapitalis11.5%,whatistheproject'sinternalrateofreturn(IRR)?
13.6%.
10.0%.
$3,875.
Explanation
SinceweareseekingtheIRR,theanswerhastobeintermsofarateofreturn,thiseliminatestheoptionnotwrittenina
365/t (365/44)
Question#44of72 QuestionID:412898
A)
B)
C)
Question#45of72 QuestionID:412890
A)
B)
C)
Question#46of72 QuestionID:412876
A)
B)
C)
percentage.
Sincetheypayments(cashflows)areequals,wecancalculatetheIRRas:N=3PV=150,000PMT=60,317CPTI/Y=9.999
IftheholdingperiodyieldonaTreasurybill(Tbill)with197daysuntilmaturityis1.07%,whatistheeffectiveannualyield?
0.58%.
1.07%.
1.99%.
Explanation
TocalculatetheEAYfromtheHPY,theformulais:(1+HPY) 1.Therefore,theEAYis:(1.0107) 1=0.0199,or1.99%.
WhatistheeffectiveannualyieldforaTreasurybillpricedat$98,853withafacevalueof$100,000and90daysremaininguntilmaturity?
1.16%.
4.79%.
4.64%.
Explanation
HPY=(100,00098,853)/98,853=1.16%
EAY=(1+0.0116) 1=4.79%
Aninvestorbuysoneshareofstockfor$100.Attheendofyearoneshebuysthreemoresharesat$89pershare.Attheendofyeartwoshesellsallfoursharesfor$98each.Thestockpaidadividendof$1.00pershareattheendofyearoneandyeartwo.Whatistheinvestor'smoneyweightedrateofreturn?
5.29%.
0.06%.
6.35%.
Explanation
T=0:Purchaseoffirstshare=$100.00
(365/t) (365/197)
365/90
Question#47of72 QuestionID:412849
A)
B)
C)
Question#48of72 QuestionID:412880
A)
B)
C)
T=1:Dividendfromfirstshare=+$1.00
Purchaseof3moreshares=$267.00
T=2:Dividendfromfourshares=+4.00
Proceedsfromsellingshares=+$392.00
Themoneyweightedreturnistheratethatsolvestheequation:
$100.00=$266.00/(1+r)+396.00/(1+r) .
CFO=100CF1=266CF2=396CPTIRR=6.35%.
SarahKelley,CFA,isanalyzingtwomutuallyexclusiveinvestmentprojects.Kelleyhascalculatedthenetpresentvalue(NPV)andinternalrateofreturn(IRR)foreachproject:
Project1:NPV=$230IRR=15%
Project2:NPV=$4,000IRR=6%
Kelleyshouldmakewhichofthefollowingrecommendationsconcerningthetwoprojects?
AcceptProject2only.
AcceptProject1only.
Acceptbothprojects.
Explanation
Becausetheinvestmentprojectsaremutuallyexclusive,onlyoneprojectcanbechosen.TheNPVandIRRcriteriaaregivingconflictingprojectrankings.Whendecisioncriteriaconflict,alwaysusetheNPVcriteriabecauseNPVevaluatesprojectsusinganappropriatediscountrate,theweightedaveragecostofcapital.TheIRRmaynotbeamarketrate,thereforefuturecashflowsassociatedwiththeprojectmaynotbecapableofearningarateofreturnequaltotheIRR.
WhatistheyieldonadiscountbasisforaTreasurybillpricedat$97,965withafacevalueof$100,000thathas172daystomaturity?
3.95%.
2.04%.
4.26%.
Explanation
($2,035/$100,000)(360/172)=0.04259=4.26%=bankdiscountyield.
2
Question#49of72 QuestionID:412842
A)
B)
C)
Question#50of72 QuestionID:412875
A)
B)
C)
Financialmanagersshouldalwaysselecttheprojectthatprovidesthehighestnetpresentvalue(NPV)wheneverNPVandIRRmethodsconflict,becausemaximizing:
shareholderwealthisthegoaloffinancialmanagement.
theshareholders'rateofreturnisthegoaloffinancialmanagement.
revenuesisthegoaloffinancialmanagement.
Explanation
Focusingonthemaximizationofearningsdoesnotconsiderthedifferencesinriskacrossprojects,whilefocusingonrevenuesprecludesconcernfortheexpensesincurred.Earningahigherreturnonasmallprojectprovideslessofabenefitthanearningaslightlylowerrateofreturnonamuchlargerproject.
Aninvestorbuysfoursharesofstockfor$50pershare.Attheendofyearoneshesellstwosharesfor$50pershare.Attheendofyeartwoshesellsthetworemainingsharesfor$80each.Thestockpaidnodividendattheendofyearoneandadividendof$5.00pershareattheendofyeartwo.Whatisthedifferencebetweenthetimeweightedrateofreturnandthemoneyweightedrateofreturn?
14.48%.
20.52%.
9.86%.
Explanation
T=0:Purchaseoffourshares=$200.00
T=1:Dividendfromfourshares=+$0.00
Saleoftwoshares=+$100.00
T=2:Dividendfromtwoshares=+$10.00
Proceedsfromsellingshares=+$160.00
Themoneyweightedreturnistheratethatsolvestheequation:
$200.00=$100.00/(1+r)+$170.00/(1+r) .
Cfo=200,CF1=100,Cf2=170,CPTIRR=20.52%.
Theholdingperiodreturninyearoneis($50.00$50.00+$0.00)/$50.00=0.00%.
Theholdingperiodreturninyeartwois($80.00$50.00+$5.00)/$50=70.00%.
Thetimeweightedreturnis[(1+0.00)(1+0.70)] 1=30.38%.
Thedifferencebetweenthetwois30.38%20.52%=9.86%.
2
1/2
Question#51of72 QuestionID:412879
A)
B)
C)
Question#52of72 QuestionID:412843
A)
B)
C)
Question#53of72 QuestionID:412872
ATreasurybillhas40daystomaturity,aparvalueof$10,000,andiscurrentlysellingfor$9,900.Itseffectiveannualyieldisclosestto:
9.60%.
1.00%.
9.00%.
Explanation
Theeffectiveannualyield(EAY)isbasedona365dayyearandaccountsforcompoundinterest.EAY=(1+holdingperiodyield) 1.Theholdingperiodyieldformulais(pricereceivedatmaturityinitialprice+interestpayments)/(initialprice)=(10,0009,900+0)/(9,900)=1.01%.EAY=(1.0101) 1=9.60%.
ThefinancialmanageratIBFM,afarmimplementdistributor,iscontemplatingthefollowingthreemutuallyexclusiveprojects.IBFM'srequiredrateofreturnis9.5%.Basedontheinformationprovided,whichshouldthefinancialmanagerselectandwhy?
Project Investmentatt=0 CashFlowatt=1 IRR [email protected]%
A $10,000 $11,300 13.00 $320
B $25,000 $29,000 16.00 $1,484
C $35,000 $40,250 15.00 $1,758
Alloftheprojects,becausetheyallearnmorethan9.5%.
ProjectAwiththelowestinitialinvestment.
ProjectCwiththehighestnetpresentvalue.
Explanation
Whenprojectsaremutuallyexclusive,onlyonecanbechosen.Projectselectionshouldbedoneonthebasisofwhichprojectwillenhancefirmvaluethemost.Thatproject,ProjectCinthiscase,istheonewiththehighestNPV.
RobertMackenzie,CFA,buys100sharesofGWNBrewerieseachyearforfouryearsatpricesofC$10,C$12,C$15andC$13respectively.GWNpaysadividendofC$1.00attheendofeachyear.OneyearafterhislastpurchasehesellsallhisGWNsharesatC$14.Mackenziecalculateshisaveragecostpershareas[(C$10+C$12+C$15+C$13)/4]=C$12.50.Mackenziethenusestheinternalrateofreturntechniquetocalculatethathismoneyweightedannualrateofreturnis12.9%.HasMackenziecorrectlydeterminedhisaveragecostpershareandmoneyweightedrateofreturn?
Averagecost Moneyweightedreturn
365/t
365/40
A)
B)
C)
Question#54of72 QuestionID:412902
A)
B)
C)
Question#55of72 QuestionID:412897
A)
B)
C)
Correct Correct
Incorrect Correct
Correct Incorrect
Explanation
BecauseMackenziepurchasedthesamenumberofshareseachyear,thearithmeticmeanisappropriateforcalculatingtheaveragecostpershare.Ifhehadpurchasedsharesforthesameamountofmoneyeachyear,theharmonicmeanwouldbeappropriate.Mackenzieisalsocorrectinusingtheinternalrateofreturntechniquetocalculatethemoneyweightedrateofreturn.Thecalculationisasfollows:
Time Purchase/Sale Dividend Netcashflow
0 1,000 0 1,000
1 1,200 +100 1,100
2 1,500 +200 1,300
3 1,300 +300 1,000
4 40014=+5,600 +400 +6,000
CF0=1,000CF1=1,100CF2=1,300CF3=1,000CF4=6,000CPTIRR=12.9452.
ATreasurybill,with80daysuntilmaturity,hasaneffectiveannualyieldof8%.Itsholdingperiodyieldisclosestto:
1.75%.
1.70%.
1.72%.
Explanation
Theeffectiveannualyield(EAY)isequaltotheannualizedholdingperiodyield(HPY)basedona365dayyear.EAY=(1+HPY) 1.HPY=(EAY+1) 1=(1.08) 1=1.70%.
Theeffectiveannualyieldforaninvestmentis10%.Whatistheyieldforthisinvestmentonabondequivalentbasis?
9.76%.
4.88%.
10.00%.
Explanation
365/t t/365 80/365
Question#56of72 QuestionID:412881
A)
B)
C)
Question#57of72 QuestionID:412900
A)
B)
C)
Question#58of72 QuestionID:412841
A)
B)
C)
First,theannualyieldmustbeconvertedtoasemiannualyield.Theresultisthendoubledtoobtainthebondequivalentyield.
Semiannualyield=1.1 1=0.0488088.Thebondequivalentyield=20.0488088=0.097618.
ATreasurybill(Tbill)withafacevalueof$10,000and137daysuntilmaturityissellingfor98.125%offacevalue.WhichofthefollowingisclosesttothebankdiscountyieldontheTbill?
4.56%.
4.93%.
5.06%.
Explanation
Theformulaforbankdiscountyieldis:(D/F)(360/t).Actualdiscountis10.98125=0.01875.Annualizedis:0.01875(360/137)=0.04927
Ifthemoneymarketyieldis3.792%onaTbillwith79daystomaturity,whatistheholdingperiodyield?
0.89%.
0.77%.
0.83%.
Explanation
Theholdingperiodyieldcanbecalculatedfromthemoneymarketyieldas:(moneymarketyield)(360t).Therefore,theHPYis(0.03792)(79360)=0.0083=0.83%.
ThefinancialmanageratJohnson&Smithestimatesthatitsrequiredrateofreturnis11%.WhichofthefollowingindependentprojectsshouldJohnson&Smithaccept?
ProjectArequiresanupfrontexpenditureof$1,000,000andgeneratesanNPVof$4,600.
ProjectCrequiresanupfrontexpenditureof$600,000andgeneratesapositiveinternalrateofreturnof12.0%.
ProjectBrequiresanupfrontexpenditureof$800,000andgeneratesapositiveIRRof10.5%.
Explanation
0.5
Question#59of72 QuestionID:412850
A)
B)
C)
Question#60of72 QuestionID:412901
Whenprojectsareindependent,youcanuseeithertheNPVmethodorIRRmethodtomaketheacceptorrejectdecision.OnlyProjectChasanIRRinexcessof11%.AcceptanceofProjectAreducesthefirm'svalueby$4,600.
ThefinancialmanageratKyserJonesisconsideringtwomutuallyexclusiveprojectswiththefollowingprojectedcashflows:
ProjectedCashFlows
Year ProjectM ProjectZ
0 $60,000 $60,000
1 22,500 0
2 22,500 0
3 22,500 0
4 22,500 111,000
IfKyserJones'requiredrateofreturnis11%,whichprojectwouldbechosenandwhy?
ProjectZ,becauseithasthehighernetpresentvalue.
Bothprojectsbecausetheirnetpresentvaluesarepositive.
ProjectM,becauseithasthehigherinternalrateofreturn.
Explanation
Sincetheprojectsaremutuallyexclusive,onlyoneoftheprojectsmaybechosen.ProjectZhasthehigherNPV.Ontheexam,alwaysuseNPVforchoosingbetweenmutuallyexclusiveprojects.
CashFlowInputValues
ProjectM ProjectZ
CF 60,000 60,000
CF 22,500 0
F 4 3
CF 111,000
F 1
OutputValues
ProjectM ProjectZ
NPV $9,805 $13,119
IRR 18.45% 16.62%
TheholdingperiodyieldforaTBillmaturingin110daysis1.90%.Whataretheequivalentannualyield(EAY)andthemoney
0
1
1
2
2
A)
B)
C)
Question#61of72 QuestionID:412892
A)
B)
C)
Question#62of72 QuestionID:434186
A)
B)
C)
Question#63of72 QuestionID:412852
marketyield(MMY)respectively?
5.25%5.59%.
6.90%6.80%.
6.44%6.22%.
Explanation
TheEAYtakestheholdingperiodyieldandannualizesitbasedona365dayyearaccountingforcompounding.(1+0.0190) 1=1.064441=6.44%.UsingtheHPYtocomputethemoneymarketyield=HPY(360/t)=0.0190(360/110)=0.06218=6.22%.
A10%couponbondwaspurchasedfor$1,000.Oneyearlaterthebondwassoldfor$915toyield11%.Theinvestor'sholdingperiodyieldonthisbondisclosestto:
9.0%.
1.5%.
18.5%.
Explanation
HPY=[(interest+endingvalue)/beginningvalue]1=[(100+915)/1,000]1=1.0151=1.5%
Aninvestorbuysa$1,000parvalue,10.375%coupon,annualpaybondfor$1,033.44andsellsitoneyearlaterfor$1,014.06.Whatistheholdingperiodyield?
8.16%.
8.22%.
8.14%.
Explanation
Therateofreturnequalsthe[(endingcashprice)/price]100=
[(1014.06+103.751033.44)/1033.44]100=8.16%
Abondwaspurchasedexactlyoneyearagofor$910andwassoldtodayfor$1,020.Duringtheyear,thebondmadetwosemiannualcouponpaymentsof$30.Whatistheholdingperiodreturn?
365/110
A)
B)
C)
Question#64of72 QuestionID:412886
A)
B)
C)
Question#65of72 QuestionID:412855
A)
B)
C)
Question#66of72 QuestionID:412899
A)
6.0%.
18.7%.
12.1%.
Explanation
HPY=(1,020+30+30910)/910=0.1868or18.7%.
ATbillwithafacevalueof$100,000and140daysuntilmaturityissellingfor$98,000.Whatisthebankdiscountyield?
4.18%.
5.14%.
5.41%.
Explanation
Actualdiscountis2%,annualizeddiscountis:0.02(360/140)=5.14%
Aninvestorsolda30yearbondatapriceof$850afterhepurchaseditat$800ayearago.Hereceived$50ofinterestatthetimeofthesale.Theannualizedholdingperiodreturnis:
12.5%.
15.0%.
6.25%.
Explanation
Theholdingperiodreturn(HPR)iscalculatedasfollows:
HPR=(P P +D )/P
where:
P =pricepershareattheendoftimeperiodt
D =cashdistributionsreceivedduringtimeperiodt.
Here,HPR=(850800+50)/800=0.1250,or12.50%.
AbrokercallswithaproposaltobuyaTreasurybill(Tbill)with186daystomaturity.HesaystheeffectiveannualyieldontheTbillis4.217%.Whatistheholdingperiodyieldifyouholdthebilluntilmaturity?
2.13%.
t t1 t t
t
t
B)
C)
Question#67of72 QuestionID:412847
A)
B)
C)
Question#68of72 QuestionID:412896
A)
B)
C)
Question#69of72 QuestionID:412878
A)
B)
C)
8.44%.
2.02%.
Explanation
TocalculatetheHPYfromtheEAY,theformulais:(1+EAY) 1.Therefore,theHPYis:(1.04217) 1=0.0213,or2.13%.
WhichofthefollowingisNOTaproblemwiththeinternalrateofreturn(IRR)?
NonnormalcashflowpatternsmayresultinmultipleIRRs.
SometimestheIRRexceedsthecostofcapital.
AhigherIRRdoesnotnecessarilyindicateamoreprofitableproject.
Explanation
IftheIRRexceedsthecostofcapital,thatmerelyindicatesthattheprojectisacceptablethisisnotaproblemassociatedwithIRR.Nonnormalcashflowpatternssuchascashoutflowsduringtheproject'slifecanresultinmultipleIRRs,leavingopenthequestionastowhichoneisvalid.AhigherIRRwillonlyberealizediftheproject'scashflowscanbereinvestedattheIRR,andthetrueprofitabilityofaprojectalsodependsonprojectsize,notjustIRR.
TheholdingperiodyieldofaTbillthathasabankdiscountyieldof4.70%andamoneymarketyieldof4.86%andmaturesin240daysis
closestto:
3.2%.
2.8%.
4.9%.
Explanation
4.86(240/360)=3.24%.
Thebankdiscountofa$1,000,000Tbillwith135daysuntilmaturitythatiscurrentlysellingfor$979,000is:
6.1%.
5.6%.
5.8%.
Explanation
(t/365) (186/365)
Question#70of72 QuestionID:412859
A)
B)
C)
Question#71of72 QuestionID:412867
A)
B)
C)
Question#72of72 QuestionID:412865
A)
B)
($21,000/1,000,000)(360/135)=5.6%.
BancaHakalapurchasestwofrontrowconcertticketsovertheInternetfor$90perseat.Onemonthlater,therockgroupannouncesthatitisdissolvingduetopersonalityconflictsandtheconcertthatHakalahasticketsforwillbethe"farewell"concert.Hakalaseesachancetoraisesomequickcash,sosheputstheticketsupforsaleonthesameinternetsite.Theauctionclosesat$250perticket.Afterpayinga10%commissiontothesiteontheamountofthesaleandpaying$10inshippingcosts,Hakala'sonemonthholdingperiodreturnisapproximately:
139%.
144%.
44%.
Explanation
Theholdingperiodreturniscalculatedas:(endingpricebeginningprice+/anycashflows)/beginningprice.Here,thebeginningandendingpricesaregiven.Theothercashflowsconsistofthecommissionof0.10$2502tickets=$50andtheshippingcostof$10(totalforbothtickets).
Thus,heronemonthholdingperiodreturnis:[(2$250)(2$90)$50$10]/(2$90)=1.44,orapproximately144%.
Whichofthefollowingismostaccuratewithrespecttotherelationshipofthemoneyweightedreturntothetimeweightedreturn?Iffundsarecontributedtoaportfoliojustpriortoaperiodoffavorableperformance,the:
moneyweightedrateofreturnwilltendtobeelevated.
moneyweightedrateofreturnwilltendtobedepressed.
timeweightedrateofreturnwilltendtobeelevated.
Explanation
Thetimeweightedreturnsarewhattheyareandwillnotbeaffectedbycashinflowsoroutflows.Themoneyweightedreturnissusceptibletodistortionsresultingfromcashinflowsandoutflows.Themoneyweightedreturnwillbebiasedupwardifthefundsareinvestedjustpriortoaperiodoffavorableperformanceandwillbebiaseddownwardiffundsareinvestedjustpriortoaperiodofrelativelyunfavorableperformance.Theoppositewillbetrueforcashoutflows.
Whichofthefollowingstatementsregardingthemoneyweightedandtimeweightedratesofreturnisleastaccurate?
Themoneyweightedrateofreturnremovestheeffectsofthetimingofadditionsandwithdrawalstoaportfolio.
Thetimeweightedrateofreturnreflectsthecompoundrateofgrowthofoneunitofcurrencyoverastatedmeasurementperiod.
C) Thetimeweightedrateofreturnisthestandardintheinvestmentmanagementindustry.
Explanation
Themoneyweightedreturnisactuallyhighlysensitivetothetimingandamountofwithdrawalsandadditionstoaportfolio.Thetimeweightedreturnremovestheeffectsoftimingandamountofwithdrawalstoaportfolioandreflectsthecompoundrateofgrowthof$1overastatedmeasurementperiod.Becausethetimeweightedrateofreturnremovestheeffectsoftiming,itisthestandardintheinvestmentmanagementindustry.