CFA Practice Question

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CFA Practice Question

An investment offers a 10% stated annual return. What is the equivalent return if it is continuously compounded?

A. 2.20%
B. 2.30%
C. 10.52%
Correct Answer: C

If the return is compounded continuously, it will equal e0.1 - 1 = 0.1052, or 10.52%.

User Contributed Comments 19

User Comment
danlan It should be greater than 10%, so no other choice than C
mtcfa I think this question is absolutely wrong. The continuos rate of return should be 9.53% as demonstrated in the notes. Example: An investment goes from 100 to 110, which is a 10% stated return, correct? Well accourding to the formula, the answer is ln(110/100) = 9.531%.
mtcfa I'll state that I may be mistaken. My note above does use the notes formula, but this question is looking for something altogether different.
akanimo a) the continuously compounded rate of return in the above scenario is 9.53% (as shown by mtcfa above)

b) the question is not asking for the compounded rate of return but is asking for "equivalent return"

c) by definition both the stated annual return and compounded rate of return have the same S0 and S1 but state their rates under two different assumptions ... the direct rate over a period vs the rate compounded continuously over same period ... somehow the way the question is framed the answer should still be 10% ?
faya Regarding the notes for this section: The HPR is the rate you're targetting. The question you will be asking is 'what continuously compounded rate results in that target HPR?'. In order to find that rate, you do: ln (1+HPR).

This question is different: It is asking what the effective annual rate is, given a stated rate of 0.1. ie. what is the rate if we include interest on interest, continually compunded. Hence e^0.1 - 1.
Farina If needed, you can work out the CC rate using the ICONV function on the BAII+, providing you insert 365 compounding periods per year, it gives an aswer that is very close. For this it gave a rate of 10.51558% which rounds up to the correct answer of 10.52%.
steved333 Yeah, gotta love ICONV. Only, it doesn't work in the other direction...
steved333 Ooh, yeah it does!
rt2007 in BAII+ 0.10 2nd LN -1 = .1052
TammTamm HP12C
1 enter
subtact one and the answer is 10.517
wundac In simpler term this question is asking the equivalent in 'return' of a 10% stated rate when continuous compounding is applied (future value).
The notes were about the equivalent of return received from an investment with a discrete rate as opposed to a continuous rate (past).
Sean12211 Just convert from a nominal to effective interest rate using 999999 compounding periods per year.
Mariecfa The effective annual rate, based on continuous compounding for a a stated annual rate of the continuously compounded rate of return (Rcc), can be calculated from the effective annual rate.
EAR = e^Rcc.
Since the natural log,ln, of e^x is x, we can get the Rcc from an EAR by using the ln calculator function. ln(1 + HPR)= Rcc or ln(1 + S1/S0) = Rcc
Jurrens TammTamm, you have it right (I'm using the hp12c as well), but you can just do e^(.1) - 1. Same answer, just one less step
johntan1979 This is wrong. You cannot use HPR and plow that into e.

This question is asking for continuous compounding, not effective annual rate (EAR).

Since number of compounding is not given, we assume maximum compounding, and 365 is enough:

EAR = (1 + 0.1/365)^365 -1 = 10.5156%

And to get continuous compounding, it is ln (1+EAR) = ln(1.105156) = 9.9986%
johntan1979 Here's an example from University of Minnesota:

4.1 A bank quotes you an interest rate of 14% per annum with quarterly compounding. What is the equivalent rate with continuous compounding?

The rate with continuous compounding is
ln(1 + 0.14/4)^4 = 0.1376, i.e. 13.76% per annum.

NOTE: Wharton University also gives the same method to count continuous compounding based on similar questions.
Thediceman ln(CCR+1)=rt
Thediceman Johntan1979:

For continuous compounding, let assue it compounding in min.

[1+10%/(24*60*360)]^(24*60*360)-1 = 10.517105% effective rate


vertually same
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