Endowment required ret

Hi,

Can anyone help why 1is correct? I understand that liq req is around 4% so he is being conservative on the comment 2. I also agree that 3rd comment is wrong. But can you help why Req rate of ret is between 7% and 7.5%? shouldn’t it be the higher of 2.5+1+0.65=4.15% or 4% req + 1% inf = 5%? or is he being conservative there too?

Thank you very much in advance!

A

QUESTION:

The Hoven University (HU) has asked Greenhill to manage the university’s endowment. The endowment’s spending rule dictates that it makes an annual contribution of 4% of its year-end portfolio market value to support HU’s operating budget. The annual endowment contribution represents 25% of HU’s annual operating budget. The university’s operating expenses are expected to grow at a rate of 2.5% annually, while the rate of inflation in the economy is expected to be 1% per year. Investment management expenses are estimated to be 0.65% of the market value of the endowment.

The investment committee has asked Zubov to provide his views on the risk and return objectives and liquidity constraints for the endowment. Zubov responds with the following statements: 1) “Based on the information provided, an annual total return objective in the range 7% to 7.5% would be appropriate for the fund. 2) In order to meet the endowment’s spending needs for this year, the liquidity need is in the range 4.5% to 5% of the year-end portfolio value. 3) Given the return objective and liquidity needs, the endowment’s risk tolerance is high.”

which one is least correct?

ANS: 3

least correct … is what is asked for

4%: annual contribution %

2.5%: specific inflation rate for operating expenses

0.65%: Investment management expenses

Total = 7.15%

Therefore 1) is correct

4%: annual contribution %

0.65%: Investment management expenses

Total = 4.65%

Therefore 2) is correct

@cpk123 Agreed,

Correct to say req ret equal or above 5% would be fine?

@kevinsfl got it, thanks!!