"For the coming year"

CFA Level III
#1

Thought I had this indiv return calc down but looks like needs revision. What does it mean when they say calculate the return objective for the coming year? Sounds pretty simple but having some issues. Here are some possibilities-which one is it?

A - The coming year is the upcoming 12 months starting now. Use the current net recurring in/outflows as the numerator for the calc. These are what the expenses will be over the next 12 months, and are current income/expense levels (no inflation adjustment as they are current).

B - The coming year is next year, so use inflation-adjusted income/expense items to calculate the return that, if earned over the next 12 months, will cover need for next year

I thought it was B, but looks like it may be A. I don’t understand tho why you would calculate a return that is to be earned over a period using the expenses of that same period. Doesn’t it make more sense to earn the return you will use the following year, after it’s actually earned and you have the funds to pay the upcoming expenses?

Sorry if this is confusing - any clarification is greatly appreciated.

#2

I too thought it is B. which example makes you think it is A

#3

.

#4

Hey student29, thought I was losing my mind for a sec and couldn’t find an example. But here’s one - Schweser practice exams vol 1, exam 1, AM question 1 about lottery winner Helen Jackson. Helen’s college expenses and the health insurance premiums (both of which are stated to increase with inflation) are used in the calc at current, not inflation-adjusted levels. The question asks to calculate the return for the coming year. Did you do this one?

#5

?

#6

The question in CFAI Volume 2 pg 212 about the Maclins…this one was getting to me…but I didn’t see a note at the bottom of the answer that said no inflation adjustment necessary because salary and expense increases would offset. Def losing my mind. That actually helps a lot tho - basically confirms that it’s B, I think. But still don’t know what’s up with that i’m sorry Ms. Jackson problem in Schweser

#7

ok… havent seen the volume 2 problem, but the Jackson lottery problem, I guess has been discussed here, and some of us were on the same page and found it was poorly worded.

#8

when i see next year:

1- i check if expenses are more than income; thus, adjust for inflation if needed.

2- check if there are any immediate payments

3- mark next year as a midpoint for the time horizon or end of 1 stage for time horizon (depending on the question).

4- check for future expected inheritance if any.

#9

For the Helen case, you pay your school fees and insurance at the beginning of the year. I don’t think there are any university that lets you pay after your term or any insurance companies giving you coverage before you pay them the premium

#10

Hey kys - I totally get the timing of the payments. College will be paid now and insurance will be paid monthly over the course of the year. This is exactly why the solution doesn’t make sense to me. I think the treatment of these items should be to remove them from the investable base, and in the retun calc, include the inflation-adjusted values, so that you’re figuring what the portfolio needs to earn this year to cover those expenses next year. But Schweser didn’t do that. Not sure why they left these expenses in the investable base, when they’re amounts that need to be paid now or in the short-term, and cannot be paid from another source…and cannot be used to earn return.

If you have any insight as to why the Schweser solution is correct, please do tell. I’m thinking there’s an error there.