This is about the question on endowment in 2011 am. I don’t know if it’s discussed. But then I want to know how to deal with it then on the exam?
As per suggested answer, increase in expected inflation increases risk tolerance because the endowment will demand a higher real return in future. I couldn’t think of it that way.
Also, help me how to prepare on behavioral biases and IPS. I know it’s too late. Schweser ruined it all I guess. Had to stop the test just when I reached second question. Pls suggest something.
if i remember correctly, one of the return objectives issues is that the endowment must balance significant/stable cash flows and sustainability…sustainability is about preserving LT purchasing power…the larger the expected inflation, the lower the real value of a dollar given in support to the supported organisation…to counter this we must increase risk to offset the eroding effects of inflation.
My intuition is that we don’t have to increase risk to counter inflation, it just happens. Say your return objective is 5% + Inflation. Say you tuned your assets appropriately for this return requirement.
If inflation is 2% your return will be 7%. If inflation is 10% your return will be 15%. As inflation increases your return requirement increases, hopefully your assets geared to counter inflation will do so. Just because inflation is going up, your return is going up because of inflation sensitive assets, and reverse calculated risk is automatically going up.
My intuition is that we don’t have to increase risk to counter inflation, it just happens. Say your return objective is 5% + Inflation. Say you tuned your assets appropriately for this return requirement.
If inflation is 2% your return will be 7%. If inflation is 10% your return will be 15%. As inflation increases your return requirement increases, hopefully your assets geared to counter inflation will do so. Just because inflation is going up, your return is going up because of inflation sensitive assets, and reverse calculated risk is automatically going up.