Using historical index returns for an equities market over a 20-year period, an analyst has calculated the average annual return as 5.60% and the holding period return as 170%. The compound annual index return over the period is closest to:
A. 2.69%
B. 5.09%
C. 5.24%
Ther answer is B. What I don’t understand is the equation they used to get to this answer. I have not seen this equation in Schweser. What is it?
The equation is: [(1+HPR)^1/n] - 1
It’s a simple enough equation… I just want to know what its called and where the hell it came from!
This equation is mentioned in Schweser’s: book first Page 148, discounted cash flow application.
When holding period yield (HPY) is converted into effective annual yield (EAY) or annual compound rate following equation is used
1) [1+ HPY)^365/t] -1
If EAY is given and u r required to calculate HPY just reverse the exponent
2) [1+ HPY)^t/365] -1
(where t means number of days until maturity)
what difference is here, question provides data in years rather in days so we can’t use t/365, instead we need to use 1/n where n means number of years. Rest is same
Just remember that if HPY is given in days then we have to annualized it by using 1) equation. If HPY is given in years (as in question) then use equation which u mentioned in order to calculate EAF (which is also called geometric mean or annual compound rate ).