Inflation Rate for Institution and Active Lives future real wage growth

CFA Level III
#1

breakdown of pension liability

Active lives future wage inflation: 10%

Active lives future real wage growth: 10%

70% of real wage growth is related to productivity growth and the sock market

Answer states that 30% of those 10% (real wage growth) are connected with nominal bonds.

1. Why is that 30% portion not related to real rate bond?

Trust (foundation) is set by Joshua. There is 3.3% increase of fee per year for the courses the trust is supporting, while the inflation rate if 3.1%, the management expense is 0.72%, royalties Joshua receives is 0.9% on average and gives to the trust, minimum spending requirement is 5%. Question asks for return requirement.

Answer is: 1.05*1.0072*1.033*0.991= 8.26%

2. Why we don’t need to include inflation for this calculation?

3. Also, is there any general rule for inclusion of inflation for institution calculation? I know we don’t need that for pension because discount rate already captures the inflation.

Thanks in advance!

#2

Anyone?

#3

  1. why would the 30% be the real rate bond?

  2. why would you include inflation?

  3. did you try looking in the book?

you either know it or you don’t. no excuses.

#4

I always check the book including searching previous answers on this forum. before I post anything. But thanks for checking my questions and your help as well!

  1. Notes states “Active future wage growth liability could be mimicked by nominal bonds, real return bond and euqities.” So, why that 30% has to be nominal bond instead of real rate bond?

  2. Also, the note mentions that for foundation “one useful guideline is to set a minimum return equal to the required payout plus expected inflation and fund expense.” So why we don’t need to include inflation here?

Thank you!

#5

Received an answer today from Kaplan. Posted here in case someone has the same questions. Never thought we could see two different type of inflation numbers in the question.

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You can only choose ONE form of inflation - either the general one (3.1%) or the tuition specific one (3.3%). The latter would make more sense given it is a music conservatory. Unless otherwise stated, the remaining 30% should be to nominal bonds. It would specifically have to tell you it was inflation indexed in order to consider real rate bonds. In the absence of any information, you assume it is not inflation indexed or linked to equity returns. That’s a reasonable assumption.