Money Weight Return Problem

[Maria1177]

I have NO idea how to do this one. I think the returns are what is confusing me.
Three years ago, you gave $10,000 to the investment company Dewey, Chetum and Howe to manage on your behalf. The annual performance of the fund was 5%, -10%, 17%. At the end of year 1 you added $1,000 to the fund and at the end of year 2 you withdrew $8,000 from the fund. Today, the end of year 3, the fund is worth $2,749.50
The money weighted return is closest to:
a) 3.4%
b) 3.7%
c) 4.0%
d) 5.5%

 

[S2000magician]

I get -1.06%:

• CF0 = 10,000
• CF1 = 1,000
• CF2 = -8,000
• CF3 = -2,749.50

Solve for IRR = -1.06%
What did they give as an answer, and as an explanation?

 

[blackjack21]

Logically, it should be very less because he withdrew it before the period of highest returns. Thank God I knw this well. Thanks to you magician. Was fighting over this concept while revising today; hence, the urge to look it up.

 

[TheLakeHouse]

Hi,
Why is there the negative sign for $2,749.50? I am a little bit confused here …
Thanks

 

[Maria1177]

They didn’t give an answer and I’ll be dammed if I can figure it out. I’ve just burned through two pieces of paper trying.
I think they want you to have the $10,000 as positive as well as the $1,000 then the two withdrawals are negative.
However, in the material they only talk about cash flows…NOT returns. Notice also that the question says “Three years ago you invested in the fund”.
Anyone got any bright ideas?

 

[breadmaker]

Geometric average?????
(1.05 * 0.9 * 1.17) ^ (1/3) - 1 = 3.4%

 

[S2000magician]

TheLakeHouse wrote:Hi,

Howdy!

TheLakeHouse wrote:Why is there the negative sign for $2,749.50? I am a little bit confused here …

For an IRR calculation, you have to think of cash flows. When they tell you that the ending balance is $2,749.50, the associated cash flow would be that you withdraw that from the account, terminating the investment; hence, a negative cash flow (from the account’s perspective).

TheLakeHouse wrote:Thanks

You’re welcome.

 

[robjames1984]

breadmaker wrote:
Geometric average?????
(1.05 * 0.9 * 1.17) ^ (1/3) - 1 = 3.4%

surely this is the time-weighted return?

 

[S2000magician]

robjames1984 wrote:

breadmaker wrote:Geometric average?????
(1.05 * 0.9 * 1.17) ^ (1/3) - 1 = 3.4%

surely this is the time-weighted return?

Yes, that’s time-weighted, not money-weighted.

 

[jdamian123]

I am getting -1.0582% IRR…
CF0 = -10,000
CF1 = -1,000
CF2 = +8,000
CF3 = +2,749.5
Thus, IRR of -1.0582%…I don’t know then, did you write down the question correctly?

 

[BlueTrin]

If you look at 1.055^3 x 10000, it is very close to 1000+8000+2749.5, I think they made a mistake.
Well I tried to compute the IRR with an inverted 1000 and do not get any of the other answers, no clue.

 

[TheLakeHouse]

Thanks, Magician. I encountered the similar question in mock 2012 AM last night and still feel obscure about their explaining. I will review this part today and make sure that I master it. I have not come back to this for a while. Maybe I should stop obsessing about positive/negative signs and start thinking of it in account’s perspective …..

 

[S2000magician]

TheLakeHouse wrote:Thanks, Magician.

My pleasure.

TheLakeHouse wrote:I encountered the similar question in mock 2012 AM last night and still feel obscure about their explaining. I will review this part today and make sure that I master it. I have not come back to this for a while. Maybe I should stop obsessing about positive/negative signs and start thinking of it in account’s perspective …..

Sounds like a plan!

 

[TheLakeHouse]

I revisited this kind of excercise again today and feel much better now. Thank you. I also notice that if at the end of Year 1 they withdraw , for example, $500, and at the beginning of Year 2 they invest $ 1,500, the cashflow for Year 2 will be 1000-500 = $500 (from the account’s perspective). Seems it’s like receiving a dividend of $500 at the end of year 1 and buying new shares that cost $1,500 at the beginning of year 2.
Just a little penny reminder for those who forget this.

 

[proanalyst]

What the correct answer?

 

[S2000magician]

proanalyst wrote:What the correct answer?

Well, the money-weighted return is -1.06%; of the choices given it’s closest to +3.4% (A), but surely that’s not what they intended.
Something’s amiss with the question or the answer choices.