CFA Level I · CFA Level I Exam · Types of Financial Returns
A portfolio returns +50% in year one and -50% in year two. An analyst reports the arithmetic mean return and the geometric mean return. The geometric mean annual return is closest to:
The geometric mean annual return is about -13.4%. The product of 1.5 and 0.5 is 0.75, and its square root is 0.866. The arithmetic mean of 0% hides the loss, and -25% is the cumulative two-year result, not the annual rate.
- A-13.4%Correct
- B0.0%
- C-25.0%
Explanation
Growth factors: 1.5 × 0.5 = 0.75. The square root of 0.75 is 0.8660, so the geometric return is -13.4%. The arithmetic mean is 0%, which is the distractor. -25% is the total two-year loss, not the annual rate.
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