Does anyone have trouble in essay test 2008? In Question 1 IPS for individuals In Part A/ii : they compute nominal required return by dividing outflow (mortgage cost) by investable asset and then add inflation. In part D/ii: They don’t add inflation. Can you explain clearly why they did that? Tks you

The question states the client wants to maintain their standard of living and the PM said they needed 15 million to achieve their goals. The PM already took into account inflation.

yeah makes sense but D caught me with the inflation…i need to get lucky on the IPS returns calc in the exams …

I got the D right but the A wrong . I forgot to add/geometrify inflation , because I was thinking that the mortgage payments ( the only required spending) are nominal anyway , so why add inflation? still have lingering doubts on that one . But I’ll take it mechanically : Always add inflation

I am much confused by the solutions too. In the last of the solution, thThere is a “Note” in which it stated : Salaries/expenses are a “wash”. What does this mean ?

Salary=living expenses , leaving Mortgage payment as the only remaining expense to be fulfilled

Then the conditions of Part A/ii & Part D/ii are same except what is explained by bpdulog. But I don’t think I can catch such an implied information, especially under time pressure on the exam.

Yes, in fact, the two cases are the same. The only effective cashflow is mortgage payment which took into account inflation. So why do I need to add inflation in A section? Still confused. We has nothing to do with salary and living expenses as they fully offset each other.

Maybe the portfolio bleeds or depreciates at the rate of inflation , all things equal, and it has to make up the bleeding in real-value terms?

Unless I catch it, I’m just gonna adjust for inflation and taxes automatically. CFA can have their 2 points out of 25, I’m not gonna fret about it.

they will hopefully eliminate the question if they realize that half got it one way and half the other ? I could clarify for them: Mortgage Payment is fixed , not dependent on inflation. So return requirement is just (constant mortgage payment amount/( net assets) With an explanation like that , can they argue I’m wrong ? If so what would the reason be?

I’m not sure why there was no accounting for taxes in this question. They need 55,000 from portfolio to fund the mortgage, are taxable investors, and yet they don’t pay any taxes on their withdrawals in the CFAI answers?

Mortgage is often tax deductible , although probably not dollar-for-dollar. In another thread on this forum , concerning the same question , there was some discussion on taxes. Unfortunately CFA does not have a clear view on how to handle this and inflation too I think. I was more concerned with the inflation aspect. If you have a 15 or 30 years loan , you’re still paying the same mortgage ( i.e. exactly 55,000 per annum ) on the last year as the first. So where’s the inflation to provide for?

qqqqqq Wrote: ------------------------------------------------------- > I’m not sure why there was no accounting for taxes > in this question. They need 55,000 from portfolio > to fund the mortgage, are taxable investors, and > yet they don’t pay any taxes on their withdrawals > in the CFAI answers? Salary and mortgage payment are presented after tax and they’re looking for the after tax return, not pretax.

I am the sqeaky wheel here , what about inflation dude? Why you need inflation adjustment if you pay exactly the same every year to mortgage? Also qqqq is correct: “mortgage payment are presented after tax” does not appear out of thin air, it is a pre-tax amount that is generated by the portfolio , that is then taxed by government, so the portfolio has to generate the pre-tax return , which is not 55,000 but more than that. If they said 55,000 pre-tax , we’d be done here, but they say after-tax , so we have to provide for tax. They don’t do this. And NOT provide for inflation… because for a fixed mortgage there is no need

janakisri Wrote: ------------------------------------------------------- > I am the sqeaky wheel here , what about inflation > dude? Why you need inflation adjustment if you > pay exactly the same every year to mortgage? > > Also qqqq is correct: > “mortgage payment are presented after tax” does > not appear out of thin air, it is a pre-tax amount > that is generated by the portfolio , that is then > taxed by government, so the portfolio has to > generate the pre-tax return , which is not 55,000 > but more than that. If they said 55,000 pre-tax , > we’d be done here, but they say after-tax , so we > have to provide for tax. They don’t do this. > > And NOT provide for inflation… because for a > fixed mortgage there is no need The salary and mortgage payment is presented after tax and you’re looking for the return after the effects of tax, I don’t see what the confusion is. If they were looking for the pretax return, then you would adjust for taxes. If they gave pretax numbers and wanted the after tax numbers, then you would also adjust for taxes. Since the return they’re asking for is after tax and the numbers presented are after tax, then no adjustment is needed. As far as inflation is concerned, I don’t know. That’s the way they do it so that’s the way I’m gonna do it.

bpdu, upon further analsysis , I agree with you on both points. It does say “After-Tax return” and it does say “nominal” in the question

Yeah I agree with janakisri. I need 55,000 after-tax to fund the mortgage, and since I am withdrawing from a taxable account I need to generate higher returns to pay the tax liability from withdrawing. I suppose a hint not to account for taxes was that there were actually two tax rates in the question: 20% on dividends & interest and 15% on capital gains. So there was no way of knowing which tax rate to apply to withdrawals from the portfolio.

qqqqqq you are right on this point as well, and I remember thinking about it for a fleeting moment as I was doing the q.

Actually no systematic principles and/or rules are described/stated in the curriculum at all.