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Study Session 2
Quantitative Methods (QM)
READINGS:
1. The Time Value of Money
4. Probability Concepts
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If you can handle the follow items from SS2 you should be in good shape for the exam.
1. Calculate EAR given stated annual interest rate
2. Calculate PV and FV for Annuities and Lump Sums and Perpetuities
3. Calculate NPV and IRR
4. State Problem with IRR
5. Calculate HPR (Total Return)
6. Calculate TWRR and MWRR
7. State difference between TWRR and MWRR
8. Calculate BDY, HPR, EAY, BEY and MMKT YIELD for a T-Bill
9. Calculate relative and cumulative frequencies
10. Comment on dataset presented
11. Calculate mean, Geometric Mean, harmonic mean, median and mode
12. Calculate range, mean absolute
13. Calculate standard deviation for a sample
14. Use Chebyshev
15. Calculate CV and Sharpe
16. Comment on skewness
17. Calculate covariance and correlation using probabilities
18. Calculate standard deviation using probability
19. Calculate standard deviation and expected return for a portfolio
20. Use Bayes formula
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TVM Examples:
1.
As of January 1, 2013, an annuity offers $5,000 per year for seven years with the first
payment due January 1, 2018. If the annual interest rate is 11.5%, what is the present
value of the annuity?
A. $13,453
B. $23,185
C. $15,000
2.
3.
Three years ago an investors portfolio was worth $55,000. If it is worth $92,000 today,
then the compound annual growth rate is closest to:
A.
B.
C.
67.2%
55.7%
18.7%
Solutions:
EAR Example:
EAR = ( 1 + i/n)n 1
EAR = ( 1 + 8%/2)2 1 = 8.16%
EAR = ( 1 + 8%/12)12 1 = 8.29%
TVM Examples:
1.C
First find value of annuity as of January 1, 2018:
BGN, FV = 0, I = 11.5, N = 7, PMT = 5,000, CPT PV = 25,851.47
Now find value as of January 1, 2013:
FV = 25,851.47, I = 11.5, N = 5, PMT = 0, CPT PV = 15,000.68
2.B
3.C
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Internal Rate of Return (IRR) is the discount rate which sets the NPV equal to zero
If IRR is greater than the cost of capital, make the investment as it will have a positive
NPV
If IRR is less than the cost of capital, decline the investment as it will have a negative
NPV
IRR problem is related to multiple IRRs produced by non-normal cash flow patterns
Bottom Line:
The timing of the cash flows will affect the reported return performance, so we must use a
return calculation method that accounts for the cash flows
Make sure you know the difference between the time weighted rate of return(TWRR) and
the money weighted rate of return(MWRR)
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Solution:
The money-weighted rate of return is the internal rate of return (IRR) of the cash flows
associated with the investment.
Use the cash flow (CF) function of a financial calculator and enter:
CF0 = 85
CF1 = 2
CF2 = 2.25
CF3 = 102.75
Calculate the IRR to find the MWRR as 8.15%.
The time weighted rate of return measures the compound rate of growth of $1 initially
invested over a stated measurement period. The TWRR is not affected by cash withdrawals or
additions and is calculated as the geometric mean of the holding period returns for each subtime period included in the measurement period.
HPR1 = [(88 85) + 2] / 85 = 0.0588235
HPR2 = [(85 88) + 2.25] / 88 = -0.008522
HPR3 = [(100 85) + 2.75] / 85 = 0.208823
TWRR = [(1 + HPR1)(1 + HPR2).(1 + HPRN)]1/N 1
TWRR = [(1 + 0.0588235)(1 - 0.008522)(1 + 0.208823)]1/3 1
TWRR = 8.2654%
TWRR => GIPS!!!!
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T-Bill Example:
A T-Bill matures in 75 days and has a yield of 3.75%
Based on the information given above, calculate the following:
a) Holding Period Return
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