Rates and Returns: practice question
An analyst at Dremmon Capital buys a unit of a listed closed-end fund for $50.00 and sells it three months later for $52.00, receiving no income during the period. The effective annual return on this investment is closest to:
- 4.00%
- 16.00%
- 16.99%
Show answer and explanation
Correct answer: C
Working: Three-month HPR = (52.00 - 50.00)/50.00 = 4.00%; annualized with compounding: (1.04)^4 - 1 = 16.99% (check: simple scaling 4.00% x 4 = 16.00%).
Explanation: The 4.00% return was earned over a single quarter, so annualizing compounds it four times: (1.04)^4 - 1 = 16.99%, which assumes each quarter's proceeds are reinvested and grow at the same quarterly rate. The 4.00% figure is the holding period return itself - a three-month rate that cannot be compared with annual returns on other investments. The 16.00% figure annualizes by simple multiplication (4.00% x 4) and ignores the interest that the first three quarters' gains would themselves earn during the fourth quarter.
More Quantitative Methods practice Try a mock exam
More free Quantitative Methods questions
- A client of Orlund Capital deposits $5,000.00 into an account paying 7.00% interest compounded…
- An equity analyst holds a prior probability that Vexley Consumer will beat its next earnings…
- Testing H0: μ = 0 against Ha: μ ≠ 0 at the 5% significance level with a large sample, an analyst…
- A quantitative analyst at Delmora Bank estimates the covariance between the annual returns of the…