AFX3355_TuteEx5_Soln

AFX3355_TuteEx5_Soln - -1- AFX3355 Property Investment...

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- 1 - AFX3355 Property Investment Tutorial 5 – Solution guidelines GM Chapter 9: Q’s 9.1 – 9.3, 9.5, 9.9 – 9.12 Q 9.1 Describe the two fundamental types of return measures. Ans: Periodic returns – holding period return (HPR) multi-period returns – typically measures using internal rate of return (IRR). See GM Section 9.1.1. Q 9.2 Explain the difference between time-weighted and dollar-weighted multi- period return measures. Ans: Time weighted: assumes all cash flows occur at ends of periods – an example is the HPR. For long periods it tends to be inaccurate (longer that quarterly). (See GM Section 9.2.2) The IRR is a dollar weighted (or money-weighted) return because it reflects the effect of having different amounts of money invested at different periods of time during the overall lifetime of the investment. Q 9.3 In what situations (or applications) is it most advantageous to use periodic returns? When does it make the most sense to employ multi-period return measures? Ans: Periodic returns are more relevant at the macro-level and in examining portfolios of investments. They allow property investment performance to be quantified on the same type of metric that is used for the main components of most institutional portfolios, stocks and bonds. Periodic returns also facilitate the measurement of the risk in investment performance by making possible the quantification of the variability of returns over time (asset volatility). Also, it is useful for comparing investment managers. Multi-period (IRR) is the classical measure of investment return at the micro- level of individual properties and development projects. Advantages: IRR does not require the market values at the intermediate points in time (note periodic returns require this information) which is common with property – buy and hold for several years with the value of the market value of the asset typically known at the date of purchase and the date of sale. However the intermediate cash flows (the rent) are known with a high degree of certainty due to lease contracts. Also, the IRR is a dollar weighted measure, taking into account when the cash flows occur.
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- 2 - Q 9.5 Consider two real estate investments. One offers 10% expected return with volatility of 10%; the other a 15% return with volatility of 20%. Is it possible to say, from just this information, which one is the better investment? [Hint: Consider Exhibit 9-2.) Ans: Return per unit of risk: Investment One – 10%/10% = 1 Investment Two – 15%/20% = 0.75 Investment Two is not as attractive as investment One as it does not adequately compensate for risk relative to One . Return is linearly related to risk (as in the following diagram) with a higher premium demanded for more risky assets. The risk profile of the investor is important in assessing risk.
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This note was uploaded on 05/18/2008 for the course AFX 3355 taught by Professor John during the Three '08 term at Monash.

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AFX3355_TuteEx5_Soln - -1- AFX3355 Property Investment...

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