'In Today's Dollars'

If this sentence is given in an IPS return calculation.

Such as Tom needs X amount _ in today’s dollars _. Does this mean we dont need to add inflation?

Just the opposite.

Sorry Bill, could you please elaborate? So if it states in today’s dollars we need to account for future inflation by adding inflation on too?

That’s correct.

Suppose that you have _ Tom has _ $1,000,000, inflation’s 2%, and next year you want _ Tom wants _ $1,000,000 in today’s dollars.

Your _ Tom’s _ required return isn’t 0%, it’s 2%.

Hi Bill - in the 2007 exam, Q1A requires us to account for a $3mn gift 35yrs from now in “today’s dollars.”

When taking the FV, I discounted the $3mn over 35, to today’s value for apples to apples PV and FV values in the calculator.

Don’t quite understand why I would just take the $3mn (as simple as it may be, I’m having a hard time wrapping my head around what’s real and what’s nominal).

I’d greatly appreciate your help. Thanks so much.

Everything in that calculation is in today’s (Canadian) dollars: their asset base (PV = CAD4,000,000), their living expenses (PMT = CAD−205,000), and their expected bequest (FV = CAD−3,000,000); no inflation. Therefore, when you calculate the return (i), it doesn’t have inflation in it: it’s a real rate. Because the question asked for the nominal, pre-tax rate, you have to add inflation to that rate.

You could use nominal (Canadian) dollars, but it’s a lot more difficult: PV = CAD4,000,000, PMT1 = CAD−205,000, PMT2 = CAD−210,125 (= CAD−205,000 × 1.025), PMT3 = CAD−215,378, . . ., PMT35 = CAD−474,641, FV = CAD−6,945,966 (= CAD−3,000,000 × 1.02535), and solve for i (which comes out to 7.3000%, by the way: pretty close to the 7.34% they got), but that would be absurdly long on your calculator (which might not even allow you to put in 36 cash flows).

Thanks Bill! You’re the best!

My pleasure.

Hi Bill,

May I know if there is an error in this solution?

Text (Answer to Question 8 in Schwesser Reading 32)

Once we determine the future, after-tax amount necessary to provide for the grandchildren’s educations in “today’s” dollars and the after-tax nominal annual travel expenses, we can solve for the after-tax required return using a financial calculator: FV = – college expenses (fixed, after-tax amount in “today’s” dollars) PMT = – travel expenses (assumed constant nominal , after-tax) PV = $1,000,000 N = 10 CPT → I/Y = after-tax real return in “today’s” dollars We then add inflation to arrive at the after-tax, nominal required return. Expenses are already expressed in nominal terms, so we do not have to adjust them for inflation. The inflation adjustment is necessary to protect the real value of the portfolio.

My question

Why is the solution combining a nominal and a real figure in its computation?

  • Nominal = Travel expenses

  • Real = College expenses

Thank you.


There is.

Because the author of the question blundered.

Go ahead: try to convince me that you’re shocked.

(By the way: ain’t never gonna happen on the real exam.)

My pleasure.