Individual investor calculation please help

[Rain01]

Hi this question is regarding the required return calculation on book 2 page 168 of the CFA curriculam.

1. After calculation return of 1.17 percent it adds inflation of 3 percent to it. I do not understand it as i feel it is double counting. Inflation has already been incorporated in the cashflows from which return was calculated then why add inflation again. (example I have 100 dollars next year i need 10 dollars (after accounting for inflation) so return i need is 10 percent. As it would give me 10 dollars i need which already took care of inflation. I dont need to adjust the 10 percent return further for inflation. If the 10 dollar cashflow that i needed did not adjust for inflation then i could add adjust the required return upwards but not double count tht is adjust in cashflow as well as required return. I hope this is farily obvious but i gave an example just in case).

2. A comment is made that strictly speaking the inflation rate should be adjusted upward by the portfolios average tax rate . Now i have no idea how and why this process is correct and how it works. Can someone please explain with help of example.

3. why is gold bullion not included in investable assets

4. why is magazine investment not included in investable asset or even in net worth

[cpk123]

1. You need to have 110$ after inflation. So the 10$ return on your 100$ portfolio includes inflation.

Yes - you accounted for the cash flows adjusted for Inflation. But your original portfolio did not include inflation. The added inflation is on your original portfolio value.

2. go with the approach taken - add the inflation rate. [I believe the statement has to do with - you have a 100$ portfolio - due to the effect of inflation - portfolio becomes 103$. But no tax is being paid on the 3$. so 3$ should be moved up by the average tax rate - since this is free. if 20% tax rate - the inflation should be 3/(1-0.2) = 3.75%.

3. Magazine investment of 5 Mill $ is an outflow and has been reduced from cash flows at the year 1 - to arrive at the 493,949 number - which is used to calculate the 1.17% after tax return.

4. Gold bullion would affect net worth of the inger’s - see exhibit 5, pg 168. It is not part of the investable assets - see box 1 pg. 154-155 -

Peter holds a portion of his liquid assets in gold bullion. He believes that gold provides a viable hedge against catastrophic economic surprises and plans to maintain his current holding (ˆ500,000) for the foreseeable future.

(Institute 154-155)

Institute, CFA. Level III 2013 Volume 2 Behavioral Finance, Individual Investors, and Institutional Investors. John Wiley & Sons (P&T), 6/18/2012. .

so it is not going to be invested.

[Rain01]

cpk i understand 1) thanks. i also kinda understand 3).

for

4. say i have 100 dollar. I buy a magazine investment for 50 dollars. I have converted one investible asset cash into another asset equity. So the amount of investible assets i have is still 100? so if it was taken out as 50 cash outflow it should be added back as an equity asset when consering the total investible asset you have?

5. I did not understand 2!! can you please explain again .more simpler

[cpk123]

you bought a magazine for 50$ - it is a cash outflow.

and the 494000 / 39 Million # is the 1.17% return.

Cash flow is gone. It is no longer part of the investable assets any more.

2. On the inflation part - you are making the return # higher - but not paying tax on it.

so essentially the amount should be higher than the inflation amount.

[Rain01]

cpk

i understand cashflow is gone but u also got a new thing in return for it and this is the stock that you own in the magazine company. there is no accounting for those. did they just dissapear?

[cpk123]

rain01

net return calculations are calculated as “Outflows in the next period” divided by “investable assets in the previous period”.

it is an expense as indicated by

Peter has a passion for photography and anticipates purchasing a minority interest (ˆ5 million) in Exteriors, a noted photography magazine. The purchase would reflect his desire to support the magazine’s high-quality work and might also lead to a post-retirement consulting opportunity. Because the investment is unlikely to produce meaningful current income, Peter does not intend to make any additional investment in Exteriors.

(Institute 155)

Institute, CFA. Level III 2013 Volume 2 Behavioral Finance, Individual Investors, and Institutional Investors. John Wiley & Sons (P&T), 6/18/2012. .

[Rain01]

ok cpk i get your point but i think its subjective whether u treat is as an expense or a an asset. but i get your point.

[Samant_Singh]

Hi there, I think 4.17% is justified as in if you break total return in to income and growth components…1.17% is needed to meet the expenses that would be incurred in year 2 and the assets base in order ti retain its purchasing power should also grow by an additional 3% (the inflation rate)…