ACST202/ACST851 : Mathematics of Finance

Tutorial Solutions 8 : Measuring Investment Performance

Question 1
(a) The 2001 TWRR is i p.a. where
1,308, 000 − 250, 000 1, 261, 000 + 100, 000
× = 1+ i
1, 000, 000 1, 308, 000
i = 10.087%
The 2002 TWRR is i p.a. where
1, 605, 000 − 290, 000 1, 440, 000 + 250, 000
× = 1+ i
1, 261, 000 1, 605, 000
i = 9.805%
The overall TWRR is i p.a. where
1,308, 000 − 250, 000 1, 261, 000 + 100, 000 
 × 
1, 000, 000 1,308, 000
 = (1 + i )
2

1, 605, 000 − 290, 000 × 1, 440, 000 + 250, 000 
 1, 261, 000 1, 605, 000 
i = 9.946%
Alternatively, using the previous results
1.10087 × 1.09805 = (1 + i )
2

i = 9.946%
(b) This is just the last equation given above, so the result is 9.946%, the TWRR for the 2 year
period. A linked rate of return using time-weighted rates of return as input produces a time-
weighted rate of return.
(c) The 2001 MWRR is i p.a. where

1, 000, 000 (1 + i ) + 250, 000 (1 + i ) 2 − 100, 000 = 1, 261, 000

1

1, 000 (1 + i ) + 250 (1 + i ) 2 − 1, 361 = 0

1

This is a quadratic in (1 + i ) 2 . Applying the general quadratic formula and ignoring the
1

unreasonable negative route gives:

(1 + i )
1
2
= 1.048297
i = 9.893%
The 2002 MWRR is i p.a. where

1, 261, 000 (1 + i ) + 290, 000 (1 + i ) 2 − 250, 000 = 1, 440, 000

1

1, 261(1 + i ) + 290 (1 + i ) 2 − 1, 690 = 0

1

(1 + i )
1
2
= 1.048381
i = 9.910%
(d) The 2 year MWRR is i p.a. where

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 1, 000, 000 (1 + i ) + 250, 000 (1 + i ) 2 − 100, 000 (1 + i ) + 290, 000 (1 + i ) 2 − 250, 000 = 1, 440, 000
2 11 1

100 (1 + i ) + 25 (1 + i ) 2 − 10 (1 + i ) + 29 (1 + i ) 2 − 169 = 0
2 11 1

We have no easy direct way to solve this. (Those of you doing a double degree with maths
might know a general method for solving quartic polynomial equations, but that’s still
horribly tedious compared to using a spreadsheet.)
By spreadsheet, the solution is 9.902%. Varying the starting guess does not alter the answer,
so we suspect there is only 1 solution.
(e) The linked rate of return is i p.a. where
1.09893 ×1.09910 = (1 + i )
2

i = 9.901%
A linked return that combines MWRRs has no direct physical interpretation, but often, as in
this example, it gives a good approximation to the MWRR for the whole period.
If you do all the calculations on a spreadsheet for greater accuracy, the linked rate of return is
9.90146% and the MWRR is 9.90203%. For most practical purposes, the difference is
negligible.
Alternatively, evaluating the left hand side of the last equation in (d) at 9.901% gives -0.0027,
which is very close to zero, showing 9.901% is very close to the MWRR.

We seek the solutions on i > −1 to 100 (1 + i ) + 25 (1 + i ) 2 − 10 (1 + i ) + 29 (1 + i ) 2 − 169 = 0

2 11 1
(f)

Substituting x = (1 + i ) 2 gives:
1

f ( x ) = 100 x 4 + 25 x3 − 10 x 2 + 29 x − 169 = 0 with x > 0 .

Since this is a 4th degree polynomial, it could have as many as 4 solutions, but the
investigation in (d) suggests there is only 1.
f ' ( x ) = 400 x3 + 75 x 2 − 20 x + 29

f ′′ ( x ) = 1, 200 x 2 + 150 x − 20

−150 ± 1502 − 4 (1, 200 )( −20 ) −15 ± 1185

f ′′ ( x ) = 0 ⇒ x = =
2, 400 240
The solutions are
α ≈ −0.2059 f ′ (α ) ≈ 32.8060
β ≈ 0.0809 f ′ ( β ) ≈ 28.0847

f ′ ( x ) is a cubic polynomial, and so is a continuous function. The above values give the
locations of its turning points. The turning points show f ′ ( x ) has exactly 1 zero which is
somewhere below α , so we can be sure f ′ ( x ) > 0 for all x > 0 .

This means f ( x ) is strictly monotonic increasing on x > 0 . Since f ( 0 ) = −169 and

lim f ( x ) = ∞ , we conclude f ( x ) = 0 has exactly one solution on x > 0 . This means there is
x →∞

a single solution for the MWRR.

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 Solutions to Additional Exercises 8
Question 1
In each part, we’ll let the required rate be i p.a.
(a) 2005: $1, 000, 000 (1 + i ) = $1, 032, 000 ⇒ i = 3.2%

2006: ( $1, 032, 000 + $1, 000, 000 )(1 + i ) = $2,125, 472 ⇒ i = 4.6%

2007: ( $2,125, 472 + $1, 000, 000 )(1 + i ) = $3, 225, 487 ⇒ i = 3.2%

(1 + i ) = 1.032 ×1.046 × 1.032

3
(b)
i = 3.665%
1, 000, 000 (1 + i ) + 1, 000, 000 (1 + i ) + 1, 000, 000 (1 + i ) = 3, 225, 487
3 2
(c)

(d) The rates of return for the 3 calendar years are 3.2% p.a., 4.6% p.a. and 3.2% p.a. (No cash
flows occur within the calendar years, so for each calendar year, the MWRR equals the
TWRR.)
The order can be determined by noting the MWRR is roughly a weighted average of the yields
obtained for individual calendar years, the weights being the products of the amount invested
and the length of time for which a particular yield applied. Here we are dealing with
combining data for calendar years, which have equal length, so the weights simplify to being
the amount invested. The ratio of the amounts invested for the 3 calendar years are near
enough to 1:2:3.
In increasing order, the rates are:
MWRR for the 2005 calendar year: clearly 3.2%, the same as the time weighted rate.
MWRR from 1/1/2005 to 31/12/2007: roughly 4 parts at 3.2% to 2 parts at 4.6%.
MWWR from 1/1/2006 to 31/12/2007: roughly 3 parts at 3.2% to 2 parts at 4.6%.
MWRR from 1/1/2005 to 31/12/2006: roughly 1 part at 3.2% to 2 parts at 4.6%.
Question 2
(a) The TWRR is i p.a. where
43,800, 000 − 500, 000 41, 700, 000 + 5, 000, 000 55,300, 000
× × = (1 + i )
2

46, 400, 000 43,800, 000 41, 700, 000

i = 14.868%
(b) The money weighted rate of return is i p.a. where

46, 400, 000 (1 + i ) + 500, 000 (1 + i ) 2 − 5, 000, 000 (1 + i ) = 55,300, 000

2 11

464 (1 + i ) + 5 (1 + i ) 2 − 50 (1 + i ) = 553
2 11

By spreadsheet MWRR = 14.089% pa. You can do this by coding the left hand side of the
above equation into the spreadsheet and using the Goal Seek tool. Alternatively, you can put
the stream of cash flows 464, 5, -50, 0, -553 into the IRR function, which will return the
MWRR as an effective half-yearly rate, and then convert that result to an annual rate.

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Question 3
(a) F1 = F0 + C + I
(b)
F0 (1 + i ) + C (1 + 12 i ) ≈ F1
i ( F0 + 12 C ) ≈ F1 − F0 − C
i  F0 + 12 ( F1 − F0 − I )  ≈ I
i [ 12 F0 + 12 F1 − 12 I ] ≈ I
2I
i≈
F0 + F1 − I
2I 2 × 594,628
(c) i≈ = ≈ 5.8%
F0 + F1 − I 10,148,267 + 10,905,933 − 594,628

(d) I = 1, 261, 000 − (1, 000, 000 + 250, 000 − 100, 000 ) = 111, 000

2 × 111, 000 222

MWRR ≈ = = 10.33%
1, 000,000 + 1, 261, 000 − 111, 000 2,150
This is a long way from the correct answer of 9.893%

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