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2024 R1 Module 1.2

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Fabrizio Tello
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14 views

2024 R1 Module 1.2

Uploaded by

Fabrizio Tello
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Quantitative Methods

Time-Weighted and
Money-Weighted Returns

Time-Weighted and Money-Weighted Returns

Money-Weighted Return
The money-weighted return applies the concept of the internal rate
of return to investment portfolios.

Internal rate of return (IRR)


 The interest rate at which a series of cash inflows and outflows sum
to zero when discounted to their value today
 Cash inflows and outflows have a net present value of zero

The MWR is defined as the IRR of a portfolio, taking account of all


cash inflows and outflows.
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© Kaplan, Inc.

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Time-Weighted and Money-Weighted Returns

Money-Weighted Rate of Return


Example:
An investor buys a share for $100 at T0. At the end of Year 1, she
buys an additional share for $120. At the end of Year 2, she sells
both shares for $130 each. The stock pays a dividend of $2 at the
end of each year. Calculate the money-weighted rate of return.

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© Kaplan, Inc.

Time-Weighted and Money-Weighted Returns

Money-Weighted Return: Solution


Clear the cash flow worksheet: 2nd, CF, 2nd, CLR Work

Enter the cash flows (use +/– for negative values)


 CF0 +100 ENTER ↓ (buys initial share)
 C01 +118 ENTER ↓ (buys 2nd share, receives dividend)
 F01 1 ENTER ↓ (frequency of CF)
 C02 -264 ENTER ↓ (x2 shares, plus x2 dividends)
 F01 1 ENTER ↓ (frequency of CF)

 IRR CPT = 13.86%


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Time-Weighted and Money-Weighted Returns

Time-Weighted Rate of Return


The time-weighted return calculates a return for an individual
subperiod (e.g., days or months). Subperiod returns can be
compounded together to measure returns over longer periods.

Example:
An investor buys a share for $100 at T0. At the end of Year 1, she
buys an additional share for $120. At the end of Year 2, she sells
both shares for $130 each. The stock pays a dividend of $2 at the end
of each year, which is not reinvested. Calculate the time-weighted
rate of return.

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© Kaplan, Inc.

Time-Weighted and Money-Weighted Returns

Time-Weighted Return: Solution


Year 1: holding period return
HPR = (end / beg.) – 1
= [(120 + 2) / 100] – 1
= 22%

Year 2: holding period return


HPR = [(260 + 4) / 240] – 1
= 10%

Geometric mean = 2 1.22 × 1.1 – 1 = 15.84%


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Time-Weighted and Money-Weighted Returns

Time-Weighted vs. Money-Weighted Return


The time-weighted rate of return is not affected by the timing of cash
inflows and outflows and is the preferred measurement method of the
investment industry and the Global Investment Performance Standards.

The money-weighted rate of return is affected by the timing of cash


inflows and outflows:
 Inflows before poor performance (TWR > MWR)

 Inflows before strong performance (MWR > TWR)

 Using the TWR removes these timing distortions

 If a manager has full control over cash flows, MWR is appropriate


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© Kaplan, Inc.

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