CFA Level I · CFA Level I Exam · Returns of Financial Assets and Instruments
A fund earns a return of 1% each month, and returns are compounded. The annualized effective return is closest to:
The annualized return is about 12.68%. Compounding a 1% monthly return over twelve months gives 1.01 raised to the twelfth power, minus one. Simply multiplying by twelve gives 12%, which ignores the return earned on prior returns.
- A12.00%
- B12.68%Correct
- C13.00%
Explanation
Compounding 12 monthly returns gives (1.01)^12 - 1 = 1.12683 - 1 = 12.68%. Multiplying 1% by 12 gives 12.00%, which ignores compounding and understates the annual return.
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