When there is a short-term (< 1 year) one time cash outflow, we adjust for it by subtracting from the portfolio asset base. Can we encounter questions where there is a similar one time cash outflow, but one that is long-term in nature ( > 1 year). If yes, how do we adjust for these? Thanks.
If the cashflow is certain, I would have followed the usual ALM approach. And would have managed the surplus as you would have done in normal scenario. Just a thought
Depends on the type. If it’s a mandatory cash outflow, I would set it apart in T-Bills until the time of payment. You cannot accept shortfall for this payment -> T-Bills. However, that would be up to 1 year and maybe a bit over. If it’s in 5 years, I’d say you mention liquidity and don’t put everything in illiquid stuff.
but how does i incorporate this in my required return calc? … For the short-term cash flow its easy … just subtract from asset base … how do we adjust for a long term certain cash outflow?
but how do i incorporate this in my required return calc? … For the short-term cash flow its easy … just subtract from asset base … how do we adjust for a long term certain cash outflow?
Assume you have total $100,000 . After 1 months a cashflow of $1000 is expecyted. after 1.5 Yrs a cashflow of 2000 will hav to be born. Short term rate ( 1 m) = 5%. 1.5 yr rate T bill = 6%. Wat i would have done is invest 1000/(1.05)^.0833 in one t bill and 2000/(1.06)^1.5 in another T bill. assume these values are 990 & 1900. So i have already invested 2890 for meeting liabilities ( that’s wat i meant by ALM) . I’ll invest $97,110 as per the case now.
bhaiyyu Wrote: ------------------------------------------------------- > Assume you have total $100,000 . After 1 months a > cashflow of $1000 is expecyted. after 1.5 Yrs a > cashflow of 2000 will hav to be born. Short term \> rate ( 1 m) = 5%. 1.5 yr rate T bill = 6%. \> \> Wat i would have done is invest 1000/(1.05)^.0833 \> in one t bill and 2000/(1.06)^1.5 in another T \> bill. assume these values are 990 & 1900. So i \> have already invested 2890 for meeting > liabilities ( that’s wat i meant by ALM) . > > I’ll invest $97,110 as per the case now. I agree with this. Take the present value of the cash flows out of the asset base and use that to calculate the return requirement. Doesn’t seem like the CFA goes this route much though, judging by the past exams so far.
Great, thanks guys!
budfox427 Wrote: ------------------------------------------------------- > > I’ll invest $97,110 as per the case now. > > I agree with this. Take the present value of the > cash flows out of the asset base and use that to > calculate the return requirement. Doesn’t seem > like the CFA goes this route much though, judging > by the past exams so far. Can you elaborate on this bud? I am interested in this answer too.
mwvt9 Wrote: ------------------------------------------------------- > budfox427 Wrote: > -------------------------------------------------- > ----- > > > I’ll invest $97,110 as per the case now. > > > > I agree with this. Take the present value of > the > > cash flows out of the asset base and use that > to > > calculate the return requirement. Doesn’t seem > > like the CFA goes this route much though, > judging > > by the past exams so far. > > Can you elaborate on this bud? I am interested in > this answer too. mwvt9 as bhaiyyu explained above, in cases where there is a long-term certain cash outflow, we should take out its present value from the asset base. We then calculate the return requirement on this (lower) asset base. This is similar to what we do with a short-term cashflow with the only difference that we don’t discount short-term cashflows and take them out as given. Hope this helped.
What about when living expenses for an entire retirment period? If we know there are going to be cash outflows we don’t subtract the PV of those from the asset base in the examples I have seen.
Living expenses would take the form of ongoing expenses rather than one time cash outflow. I believe living expenses get accounted for in the numerator of the req. return calc. Your thoughts?
Most likely scnerio on the exam is that cash outflow will be required in the near future and you will simply need to subtract that amount from your investable portfolio
clueless555 Wrote: ------------------------------------------------------- > Most likely scnerio on the exam is that cash > outflow will be required in the near future and > you will simply need to subtract that amount from > your investable portfolio Agree with that.
you can do this only if provided risk-free rate. Otherwise, just subtract the entire amount from asset base (if outflow is to occur within one year). mcpass Wrote: ------------------------------------------------------- > Depends on the type. If it’s a mandatory cash > outflow, I would set it apart in T-Bills until the > time of payment. > > You cannot accept shortfall for this payment -> > T-Bills. > > However, that would be up to 1 year and maybe a > bit over. If it’s in 5 years, I’d say you mention > liquidity and don’t put everything in illiquid > stuff.
When you know for *certain* what your one time cashflows are to be, take the ALM approach, otherwise account for them in required return calculation.