CAIA - CHAPTER 3 WITH 100% CORRECT ANSWERS.

Compounding - is the recognition of interest on interest or, more generally, earnings on earnings Simple Interest - is an interest rate computation approach that does not incorporate compounding Continuous Compounding - assumes that earnings can be instantaneously reinvested to generate additional earnings Discrete Compounding - includes any compounding interval other than continuous compounding such as daily, monthly, or annual Log Return - is a continuously compounded return that can be formed by taking the natural logarithm of a wealth ratio Return Computation Interval - for a particular analysis is the smallest time interval for which returns are calculated, such as daily, monthly, or even annually Return on notional principal - divides economic gain or loss by the notional principal of the contract Notional Principal - or notional value of a contract - is the value of the asset underlying, or used as a reference to, the contract or derivative position Fully collateralized - means that a position (such as a forward contract) is assumed to be paired with a quantity of capital equal in value to the notional principal of the contract A fully collateralized position has two components of return 1. the change in the value of the derivative 2. any return on the collateral Partially collateralized position - has collateral lower in value than the notional value Internal Rate of Return (IRR) - can be defined as the discount rate that equates the present value of the costs (cash outflows) of an investment with the present value of the benefits (cash inflows) from the investment Four Types of IRR 1. Lifetime IRR 2. Since-Inception IRR 3. Interim IRR 4. Point-to-point IRR Lifetime IRR - contains all of the cash flows, realized or anticipated, occurring over the investments entire life, from period 0 to period T Since-inception IRR - is commonly used as a measure of fund performance rather than the performance of an individual investment Interim IRR - is a computation of IRR based on realized cash flows from an investment and its current estimated residual value - can be calculated on an investment purchased subsequent to its inception Point-to-point IRR - is a calculation of performance over part of an investment's life. Complex Cash Flow Patter - is an investment involving either borrowing or multiple sign changes. Borrowing Type Cash Flow Pattern - begins with one or more cash inflows and is followed only by cash outflows. - an example is when an investment such as a real estate project is sold and leased back. The divestment generates current cash at the cost of future cash outflows and may be viewed as a form of borrowing. Multiple Sign Change Cash Flow Pattern - is an investment where the cash flows switch over time from inflows to outflows, or from outflows to inflows, more than once. - an example would be a natural resource investment involving (1) negative initial cash flows from purchasing equipment and land to set up an operation such as mining, (2) positive interim cash flows from operations, and (3) negative terminal cash flows from ceasing operation and restoration expenses. Scale Differences - are when investments have unequal sizes and/or timing of their cash flows. Aggregation of IRRs - refers to the relationship between the IRRs of individual investments and the IRR of the combined cash flows of the investments. The Modified IRR - this approach discounts all cash outflows into a present value using a financing rate, and calculates the modified IRR as the discount rate that sets the absolute values of the future value and the present value equal to each other. Time-weighted returns - are averaged returns that assume that no cash was contributed or withdrawn during the averaging period, meaning after the initial investment. Dollar-weighted returns - are averaged returns that are adjusted for and therefore reflect when cash has been contributed or withdrawn during the averaging period. - the IRR is the primary method of computing a dollar-weighted return Waterfall - is a provision of the limited partnership agreement that specifies how distributions from a fund will be split and how the payouts will be prioritized - specifically, the waterfall details what amount must be distributed to the LPs before the fund manager or GPs can take a share from the fund's profits