In the answer key. They specifically tell you to use arithmetic returns, rather than geometric returns, for the return requirement calculations. Why is that? Why the arithmetic is better than geometric for this question?
If there is narrow margin between two which may imply incorrect answer as assumed by exam writer in 2016 Q1, guideline was use an arithmetic return. In other questions, both approaches are recognized as correct.
I didnt like this question because the resulting answer meant that the school could afford the subscriptions considering their risk tolerance…
Yep. The last step, interpretation was screwed.
I think is question is pretty annoying, and I hate it! It’s against what they told us in the book which is geometric method preferred.
It’s not like I can do anything about it, but there is no reason that they specifically ask us to use arithmetic method which is hidden in the unnoticeable notes and trying to set candidates to failure!
I just always use arithmetic return.
What’s really got me was the line “The administration desires the highest level subscription that the endowment can fund in perpetuity.” So using the arithmetic approach 8.5% lead me to believe they could afford the highest level subscription, since return was 8.5%.
It was a nasty question.
I don’t think any other question had ever put in the volatility expectation like this one did. Now I know, but it makes me wonder, what whacky thing are they going to pull out of the hat this year to throw us off.
Each AM had at least one such question and at least one unique question which had not appeared before.
Using a normal law, if your required return is 8.5 and your expected return is 8.5, it means that you have 50% chance to have it, for one period. Worst if compound, so I think the question was fair. But, yep, I dont know why arithmetic and not geometric.
I agree with all of you. Admittedly, I messed it up too. Felt bad for folks last year on that one. After reviewing it though with CFAI guideline answer it makes perfect sense. The arithmetic vs geometric part makes no difference other than them seeing who can follow simple instructions. I could understand the cinfusion when it matched perfectly the premium subscription. Almost looked intentional and was cruel by cfai. However, thinking like a wealth planner or PM we should know that the premium isn’t affordable or the “highest subscription they can afford”. For example, would if their portfolio has a bad few years. Well, now that 8.5% could be 15% of their portfolio. They need that cushion, making the premium unsuitable.