Dotcominous Portfolio Transactions: Dollar-Weighted Rate of Return Calculation

Dollar-Weighted Rate of Return Calculation

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Question

A portfolio manager for Smith, Kleen & Beetchnutty is examining the performance of several of her institutional customers. The following transactions apply to the account of Dotcominous, a fledgling "new media" advertising conglomerate: t0: Purchase five Kansas City District 14 General Obligation Bonds for $5,545.00 t1: Purchase three Kansas City District 14 General Obligation Bonds for

$3,229.50

Receive coupon payment of $300.00

t2: Purchase three Kansas City District 14 General Obligation Bonds for $3,185.00

Receive coupon payment of $480.00

t3: Receive coupon payment of $660.00

t4: Sell eleven Kansas City District 14 General Obligation Bonds for $11,780.00

Investments with similar characteristics merit an 11.75% required rate of return. Assuming that taxes and commissions have already been incorporated into the cash flows provided, what is the dollar-weighted rate of return for this series of transactions?

Answers

Explanations

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A. B. C. D. E. F.

B

Remember that the dollar-weighted rate of return uses the IRR equation in the determination of its answer. Further, the dollar-weighted rate of return is another name for the IRR equation, and this nomenclature is commonly used within the field of investment management. So said, the required rate of return is not explicitly factored into the calculation of the dollar-weighted rate of return, rather what is being determined is the rate which equates the present value of the cash inflows to the present value of the cash outflows. In the determination of the dollar-weighted rate of return calculation, the first step should be to identify the cash flows for each period. In this example, the cash flows have been stated, and little calculation is necessary.

The cash flows associated with this series of investments are illustrated as follows: t0: ($5,545.00) t1: [($3,229.50 paid for the bonds) + $300.00 coupon payment] = ($2,929.50) t2: [($3,185.00 paid for the bonds) + $480.00 coupon payment] = ($2,705.00) t3: $660 coupon payment t4: $11,780

Now that the cash flows have been determined, incorporating this information into your calculator's cash flow worksheet and solving for IRR will yield a dollar- weighted rate of return of 3.44% for this investment

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