Question

You plan to analyze the value of a potential 5-year investment in which you expect to earn a positive return every year. However, the yearly rate of return differs every year. Which of the following is true?

		The holding period return is best for comparison to other investments.
		The geometric mean return will be larger than the arithmetic average return.
		The holding period return is the same as the arithmetic average return.
		The arithmetic average return will be larger than the geometric mean return.
		The geometric mean and arithmetic average returns are the same.

Answer 1

ARITHMETIC AVERAGE RETURN IS SIMPLE AVERAGE OF ALL RETURNS.

GEOMETRIC MEAN RETURN TAKES INTO ACCOUNT COMPOUNDING EFFECT. SO IT IS ALWAYS LOWER THAN ARITHMETIC AVERAGE RETURN.

GEOMETRIC MEAN IS BETTER THAN HOLDING PERIOD RETURN BECAUSE HOLDING PERIOD RETURN DOES NOT TAKE INTO COMPOUNDING AND IT IS A SIMPLE RETURN OF HOLDING THE MONEY.

HOLDING RETURN IS NOT AN AVERAGE RETURN. IT DOES NOT TAKE INTO ACCOUNT TIME PERIOD.

SO THE BEST OPTION : ARITHMETIC AVERAGE RETURN WILL BE LARGER THAN GEOMETRIC MEAN RETURN (THUMBS UP PLEASE)