IMC Performance Measurement and Attribution 1 — Questions and Answers
Question 1: Which return measure eliminates the distorting effect of external cash flows and is most appropriate for evaluating investment manager performance?
- Money-weighted return
- Time-weighted return (Correct answer)
- Holding period return
- Internal rate of return
Correct answer: Time-weighted return
Time-weighted return removes the impact of the timing and size of external cash flows, making it the standard for comparing manager performance across firms.
Question 2: A portfolio is worth £100,000 at the start of the year. After six months it grows to £110,000 before an additional £20,000 is invested. By year end the portfolio is worth £143,000. What is the approximate time-weighted return for the year?
- 15.0%
- 21.0% (Correct answer)
- 30.0%
- 10.0%
Correct answer: 21.0%
Sub-period 1: £110,000/£100,000 − 1 = 10%; Sub-period 2: £143,000/£130,000 − 1 = 10%; TWR = (1.10 × 1.10) − 1 = 21%.
Question 3: A portfolio achieves a return of 12% while its benchmark returns 9%. What is the active return?
- 21%
- 3% (Correct answer)
- 1.33%
- −3%
Correct answer: 3%
Active return (alpha) = portfolio return − benchmark return = 12% − 9% = 3%.
Question 4: Which of the following is NOT a characteristic of a valid performance measurement benchmark?
- Specified in advance of the measurement period
- Investable and measurable
- Reflective of the manager's investment universe
- Chosen retrospectively to match the best-performing index that year (Correct answer)
Correct answer: Chosen retrospectively to match the best-performing index that year
A valid benchmark must be specified in advance; selecting it retrospectively to flatter results violates the principle of objectivity.
Question 5: An investor purchases a share for £50, receives a dividend of £2 during the year, and sells the share for £55. What is the holding period return?
- 10%
- 14% (Correct answer)
- 4%
- 12%
Correct answer: 14%
Holding period return = (ending price − beginning price + income) / beginning price = (£55 − £50 + £2) / £50 = 14%.
Question 6: A portfolio records quarterly returns of 3%, 2%, −1%, and 4%. What is the approximate annual time-weighted return?
- 8.0%
- 8.2% (Correct answer)
- 8.5%
- 8.8%
Correct answer: 8.2%
(1.03 × 1.02 × 0.99 × 1.04) − 1 ≈ 1.0817 − 1 = 8.17%, closest to 8.2%.
Question 7: The money-weighted return (MWR) is mathematically equivalent to which financial measure?
- Arithmetic mean return
- Geometric mean return
- Internal rate of return (IRR) (Correct answer)
- Time-weighted return
Correct answer: Internal rate of return (IRR)
The MWR is the discount rate that equates the present value of all cash inflows and outflows, which is the definition of IRR.
IMC Performance Measurement and Attribution 1
Which return measure eliminates the distorting effect of external cash flows and is most appropriate for evaluating investment manager performance?