Liquidity requirements

CFA Level III
#1

This is the Donna Everitt case in CFAI online questions 1-6 in Private Wealth Management (1)

  1. If the info says expenses are $150,000, which are expected to remain constant over time. Do you still grow the expenses by inflation?

I thought yes, but the CFAI online question bank does not. Is this right?

  1. It also says income is $150,000, which equals her living expenses. Tax rate is 40%. My understanding is her after tax income is $90,000, which falls $60,000 short of her expenses.

So her liqudiity requirement should add $60,000. But they ignore this.

#2

  1. I don’t really know what’s being asked. But, it says the expenses are expected to remain constant over time. So, no, you wouldn’t grow those, unless it explicitly states to index them for inflation. Inflation is usually added into the return requirement of the portfolio if the investor wishes to preserve the real level of the assets value.

  2. Liquidity requirements are for cash flows from the portfolio that are expected to happen within the year for all things not considered living expenses. So, the $60k shortfall is built into the return requirement, not the liquidity requirement.

#3

What about 2015 AM CFA Mock Question 7d?

They included living expenses into liquidity need (USD 200,000)…

#4

Yeah I know this, and I feel betrayed. I’m hoping someone can explain this

#5

Lot of discussion on that question. The case states income offsets expenses so they are ignored. Us smart candidates would question whether the salary is pre-tax which would lead to a the shortfall. I would hope on the actual exam they specify whether the salary is pre/post tax.

I’ve always thought liquidity requirements are any outflows of cash. I never know whether to phrase it as the total amount of cash needed during the specified period, or to net that against income for a net liquidity requirement. Would appreciate any insight.

#6

Liquidity requirement considers living expenses. So, the $60k shortfall should built into the liquidity requirement.

#7

Harry, liquidity should be considered what you actually need from the portfolio, not just what you need generally from the period. Also, there are a couple questions out there where the investor is a net saver, ie. with extra money from income above needed expenses. The logical thought process is that you can redirect any net savings towards a stated income need, thereby reducing the liquidity need, but look for key phrases along the lines of, “any savings or money not needed for expenses for the period is immediately/directly invested in the portfolio”. That would imply that the money is not available to net against liquidity needs from the portfolio, so in your mind, picture it as being deposited in the portfolio first, and if it comes back out, it will be part of the liquidity amount. It doesn’t seem logical or realistic, but that trap has been set a couple times in past mocks.