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CFA Level I · CFA Level I Exam · Types of Financial Returns

An investor buys one share at 50 at time 0 and buys a second share at 60 at the end of year 1. The investor receives a dividend of 2 per share at the end of each year and sells both shares at 70 each at the end of year 2. The money-weighted return is the rate that equates the present value of inflows and outflows. Which statement about that rate is most accurate?

The money-weighted return is the internal rate of return of the cash flows, so it sets the net present value to zero. It depends on the timing and size of flows such as the second purchase, unlike the time-weighted return.

  1. AIt is the rate that sets net present value of the cash flows to zeroCorrect
  2. BIt is the geometric mean of the yearly holding period returns
  3. CIt is unaffected by the timing of the second purchase

Explanation

The money-weighted return is the internal rate of return of the portfolio cash flows, so it sets NPV to zero. It is not a geometric mean of sub-period returns, which is the time-weighted approach, and it is sensitive to the timing of flows such as the second purchase.

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