# Explain to me core capital.

The numerator is increased by the inflation rate and this value is discounted at the Real Risk Free Rate? Wouldn’t this include inflation two times? Once in the numerator and once in the denominator.

where did you see it pls? does not make sense imo

pfcfaataf Wrote: ------------------------------------------------------- > where did you see it pls? does not make sense imo Was on the Schweser Mock Exam.

ok, searched CFAI book 2 EOC 2 solution is what we expect And, the text page 227 says for example in table on page 228 (where spending is increasing): The Websters’ inflation adjusted annual spending needs are calculated based on their current spending of €500,000 per year and are increased annually using a 3 percent REAL GROWTH RATE (that is, 3 percent annual spending growth after inflation). so it seems it grows not because of inflation but because of real growth and inflation adjusted means in real terms. Let’s hope the question would look like EOC 2 in the exam…

That’s how it’s done in CFAI and Stalla. You take the expected spending needs, adjust for inflation, multiply by combined survival probability, then discount at risk free. Can’t say why it’s done like that, it’s just the way it is.

no no… the spending needs, if they are growing, are growing always at a REAL rate (so if inflation is 3% and the spending is growing at 3%, you can think of it like a ~6% nominal growth rate). Read the question carefully again - it tripped me up until I started re-read the question and realized they always say REAL growth rate… not nominal growth rate. I’ve never seen a question like this, but I guess if the question goes “income is growing at 3% and inflation is at 3%”, then when you’re calculating the real spending, then the growth is zero. So if you are growing income in REAL rates, then you discount with REAL risk free (1+Nominal RF rate)/(1+inflation) -1 = REAL risk free rate

batgirl4ever Wrote: ------------------------------------------------------- > no no… the spending needs, if they are growing, > are growing always at a REAL rate (so if inflation > is 3% and the spending is growing at 3%, you can > think of it like a ~6% nominal growth rate). > > Read the question carefully again - it tripped me > up until I started re-read the question and > realized they always say REAL growth rate… not > nominal growth rate. I’ve never seen a question > like this, but I guess if the question goes > “income is growing at 3% and inflation is at 3%”, > then when you’re calculating the real spending, > then the growth is zero. > > So if you are growing income in REAL rates, then > you discount with REAL risk free > > (1+Nominal RF rate)/(1+inflation) -1 = REAL risk > free rate http://www.youtube.com/watch?v=1cYQV62WhkM

wow…that is tricky indeed…thanks for sharing (also the video, cracked me up).

I think the distinction is whether the spending needs are “growing” or just being adjusted for inflation in order to be “maintained”. In the case where spending is “maintained” --> Increase by inflation each year and then discount at the NOMINAL rate. In the casebwhere spending is “growing” --> Increase by rate of growth each year and then discount at the REAL rate. This is at least how I understand it…

jdane416 Wrote: ------------------------------------------------------- > I think the distinction is whether the spending > needs are “growing” or just being adjusted for > inflation in order to be “maintained”. > > In the case where spending is “maintained” --> > Increase by inflation each year and then discount > at the NOMINAL rate. > > In the casebwhere spending is “growing” --> > Increase by rate of growth each year and then > discount at the REAL rate. > > This is at least how I understand it… You got it. Schweser through a major curveball to a fairly easy concept.

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