2004 # 2: The Maclins IPS

does anyone else agree that the shortfall of 26,000 pounds should come out in the current year? (i.e. subtracted from the current portfolio value of 1,235,000 pounds) this is what the 2007 exam did! granted it was specifically stated, but, it still should come out, shouldn’t it? the logic being; they need to take care of that expense (shortfall) right now, so it should be deducted from their portfolio? comments?

TooOld4This, csk, MGG? any comments? you guys are really on top of these topics…

Why would you subtract an ongoing annual shortfall from the total asset base ?

because we are short in the current year. how else are we going to cover it? we have to cover our obligations don’t we? at least future obligations are that. so we have time to grow the portfolio to meet those? no?

26000 should still form part of your total assets as it’s not spent on day one.

so I should include it? it would still need to be taken out at the end of the year (i.e. within the year) though?

it’s an on going spending item

I agree that it is an ongoing spending item (expense) but, why wouldn’t it come out of the portfolio in the first year especially since there is no cash to meet it. Serra (2006 case) and Yeo (2005 case) adjust for ongoing expenses in the first year as well.

I’m starting to realize that the more I do these IPS type questions, the more I believe the CFAI will move away from return requirement calculations and focus more on the conceptual side of the IPS development. There’s just too many different ways to calculate things.

I sure hope they do PJS…the more of these things I do and the more I compare the various model answers, the more I come to believe the IPS portion of the morning exam is a fundamentally flawed way to test this material. Sometimes income optionality is a consideration in setting risk tolerance (the soccer player)…sometimes it isn’t (the couple with twins where the wife wasn’t working). Sometimes the current year expenses come out of the portfolio from the get-go…sometimes they are part of the return calc. Sometimes we need to simply abandon all logic in a return calculation and assume that it’s okay to figure the return required over an 18year horizon with annual cash outflows on a YTM basis, as though the outflows are going to be reinvested at the YTM and not just spent on videogames and booze… My frustration with this part of the material knows no bounds. Clearly, I have moved from bounded rationality to unbounded irrationality.

This is what i do: + if they don´t say anything about “right now”, “immediately”, “in 3 months”, etc, I assume that every item to spend happens at the end of the year (ie, one year from now) + same for inflows (ie, salary) only in special cases (where your asset base will be determined at the end of current year), you calculate net inflow/outflow, adjust the asset base, adjust the expenses of the following year for inflation, and divide that by asset base in order to get required return. Then you add inflation, divide by (1-tax) and you are done

I know there’s been a million posts about required return and what I think would be extremely helpful is if everyone posted what their exact process is for calculating required return in each scenario ie: - Lump-Sum expenses in the Current Year - Expenses that don’t begin for 5 years - Any other scenarios?

  • Substract payments specified as “immediate” - Substract present value of payments to be made in “x” time if “x” is less than one year - unless they tell to set aside a special reserve for a determined payment, don´t substract payments to be done in “x” time if “x” is longer than one year BIG DISCLAIMER: this is what I would use, not something I have taken from CFA or schweser

Would it be wrong to just deduct any expenses from the asset base that are scheduled to occur within 12 months without calculating a PV? I mean if you have a lump-sum expense in the amount of $50,000 coming in 9 months, do they really expect us to calculate the PV of it or just go ahead and deduct the $50k from the Asset base now for simplicity purposes?

That is a good point: I have not seen previous exam questions where you have to substract the PV of anything. Every expense is paid “this year”, so no adjustment for PV is necessary. The only examples where I have seen it, is in some cfa and schweser examples inside if chapter, but never as a real exam question.

Hey hala_madrid (or anyone…) this is sort of along the lines with the Maclins. whereas the maclins don’t take out the immediate shortfall of $26,000 (and I don’t know why…) if we look at another similar case; the Muellers CFAR page 202 #11 would anyone happen to know why we don’t ADD the savings/surplus of $25,000 to the portfolio value in the current year?? (why don’t we address these adjustments to our portfolio value immediately??) we seem to address them immediately in the 2006 exam with Serra and the 2005 exam with Yeo! (these individuals had 1 year to go till retirement) what is the justification, reasoning for not addressing these adjustments when the client has several years till retirement as opposed to 1 year??? Thanks gang,

Did anyone take into account inflation for Maclins’ return calculation? I have gotten to the point, where I just remember the answers to these from memory…time for new questions.

grexan Wrote: ------------------------------------------------------- > Did anyone take into account inflation for > Maclins’ return calculation? > > I have gotten to the point, where I just remember > the answers to these from memory…time for new > questions. Living expenses were offset by salary increases so inflation is irrelevant. CFAI likes to throw this into problems. It simplifies the calculations. Learn it, love it, live it.