This video discusses the concept of “Money-weighted Rate of Return”. In the next class, we will discuss the time-weighted rate of return. Please refer to “Calculate NPV and IRR using Texas Instrument BA II Plus(TM)” for IRR calculation”. The following is a part of the transcript.

Money-weighted rate of return and time-weighted rate of return are two important concepts you must understand for the CFA exam. For money-weighted rate of return, it calculates the effective return by applying the concept of Internal Rate of Return (IRR) of the cash flows. It is just like finding the pivot of the balance. Therefore, imagine this as a balance and each cash flow exerts a force on the balance.

The following are the procedures:

1)      list all cash flows (+ve for inflow and –ve for outflow)

2)      arrange them on different scales on the balance – of course, the scale is the time (months, years etc.)

3)      Find the internal rate of return so that the balance is balanced! Use the following equations:

Sum of all discounted cash flow = 0

Here discounted cash flow is just cash flow/ (1+IRR)ⁿ, where n is the number of periods the cash flow occurs from now.

Please see the video for an example.