reading 1

• How are interest rates interpreted in finance?

  As required rates of return and opportunity costs
• What do equilibrium interest rates represent?

  Required rate of return for investments
• What is the relationship between interest rates and future payments?

  Payments should be discounted at the interest rate
• What does the opportunity cost of current consumption refer to?

  Forgone earnings from saving instead of spending
• What is the real risk-free rate of interest?

  Theoretical rate with no inflation or default
• What does the real rate of return indicate?

  Increase in purchasing power after inflation
• What are T-bill rates considered?

  Nominal risk-free rates
• What types of risks increase the required rate of return?

  Default, liquidity, and maturity risks
• What is default risk?

  Risk of borrower not making payments
• What is liquidity risk?

  Risk of selling an investment for less value
• How does maturity risk affect bond prices?

  Longer-term bonds are more volatile
• How is the holding period return (HPR) calculated?

  Percentage increase in investment value
• If a stock is valued at €20, pays €1 in dividends, and ends at €22, what is the HPR?

  15% increase in value
• What does the HPR reflect over multiple periods?

  Compounding of returns
• What is the arithmetic mean return?

  Simple average of periodic returns
• How does the geometric mean return differ from the arithmetic mean?

  Geometric mean is a compound rate
• How do you calculate the geometric mean return for three annual periods?

  Use the formula for compound returns
• What is the relationship between the geometric mean and the arithmetic mean?

  Geometric mean is less than arithmetic mean
• What is the harmonic mean used for?

  Average cost of shares purchased over time
• How do you calculate the average cost per share using the harmonic mean?

  Use prices paid per share
• What happens when returns include negative numbers in harmonic mean calculations?

  Use (1 + return) for each period
• How do outliers affect measures of average return?

  They can skew the results significantly
• What is the appropriate use of the arithmetic mean?

  Include all values, including outliers
• What is the appropriate use of the geometric mean?

  Compound the rate of returns over periods
• What is the appropriate use of the harmonic mean?

  Calculate average share cost from purchases
• What is the appropriate use of trimmed or winsorized mean?

  Decrease the effect of outliers
• What does the money-weighted return apply to?

  Internal rate of return for portfolios
• What is the internal rate of return (IRR)?

  Interest rate where cash flows sum to zero
• What is the relationship between IRR and NPV?

  IRR is where NPV equals zero
• What tools can be used to calculate IRR and NPV?

  Financial calculators permitted by CFA Institute
• What is the term for the interest rate after subtracting the inflation premium?

  Real interest rate
• What is the harmonic mean of 3, 4, and 5?

  3.83
• Which mean is most appropriate for calculating XYZ stock's annual return?

  Geometric mean
• What are the differences between money-weighted and time-weighted rates of return?

  • Money-weighted: considers cash flows, IRR
  • Time-weighted: measures compound growth, averages over time
• What does the money-weighted return apply to investment portfolios?

  Internal rate of return (IRR)
• What is the net present value (NPV) when cash inflows and outflows sum to zero?

  NPV is zero
• What is the formula for calculating the money-weighted rate of return?

  IRR on a portfolio
• How do you enter cash flows into a financial calculator for money-weighted return?

  Positive for inflows, negative for outflows
• Why is the time-weighted rate of return preferred in investment management?

  It removes distortions from cash flow timing
• What is the annual time-weighted rate of return based on the given example?

  15.84%