IPS: Confused about what to write for Liquidity/Time Horizon

After doing some past A.M. exams and going over Schweser/CFAI books twice, I still don’t really know how to handle IPS regarding Liquidity and Time horizon. I always include something the solution leaves out or include something that’s not included there.

Hope that you can help me with it. Sorry, it will be a long post, but there’s a lot unclear to me.

Imagine a personal investor who get’s a huge cash inflow at year and. Currently, she’s working and her income equals her expenses. Next year, she will retire, and use the cash inflow to pay off her debts. She has a 10-year old son, who wants to go to college (case is somehow similar to a past exam, didn’t want to copy it).

The question may start with asking for required return next year, all no problem so far. Then, it asks you to define Liquidity and Time Horizon for the IPS. What would you include? And generally, if there is no additional statement, would the constraints be for next year or for now?

For Liquidity: - Would you write the amounts of this years’ expenses and income, although they cancel out? These are still liquidity flows for them. From what I’ve seen, I have the feeling that CFAI would rather exclude it. - End of year cash inflow and outflows (paying debts) should be included for sure I guess? - What about college costs? Lets say we know how much it will be, but it will occur in 8 years. From solutions I’ve seen, I would say leave it out completely on the liquidity side and probably put it under unique or so? Should definitely be mentioned somewhere I guess? - If we know the income/expenses next year (after retirement and debts repayment), will this be part of Liquidity? Or will we leave it out because it’s not relevant now? They were also used to calculate expected return, so I would have thought they should be reflected here again?

For Time Horizon: - I would have said that it’s multi-stage, long-term with 4 stages: Now until cash flow, further 7 years until son is in college, another 4 years when he is in college, and the time afterwards. However, I think I have never seen a solution with that many stages. The first part seems to be missing quite often, however it dominates her situation now? - About this college thing, which ages do you estimate when writing time horizon? Nearly every case has a child for college, could we expect them to go there at 18 and stay for 4 years? - When they enter retirement, would you give a time horizon afterwards? Assume they are 65, would you write 20-30 years, 25+ years or leave it out completely? - If we deal with a couple, is one stage always until the first of them dies, and another stage afterwards? Have seen this in one past a.m. exam, so I don’t know if that’s generally the case. - If they say that they have a second portfolio but will only start using it in 10 years, shouldn’t that be 2 stages? In the solution for past a.m. it wasn’t mentioned at all at the time horizon part, I would have included it. Seems to be quite relevant for me. - So far, I’ve only seen one-stage long-term, 2-stage long-term, multi-stage long-term, etc. Never seen any IPS with a short-term time horizon. Does this even exist?

Hope that you can give me some input on my questions.

Ok thanks! That made it a bit more clear.

Liquidity & cash reserves are tricky and honestly CFAI isn’t entirely consistent with how they handle what goes in and what goes out but in general, liquidity is a cash outflow < 1-year. After 1-year it generally becomes more of a multi-stage investment horizon. Sometimes a cash-reserve is a long-term liquidity need but generally excluded from the asset base. Sometimes the CFAI text will have you take the PV of the 2 or 3 year liquidity need and invest it into cash like securities, othertimes they just set it aside without discounting it. The context of the question is, obviously, very important.

Time-horizon is always in persective of the future known events, each event is a stage. First stage could be from now until the kid goes to college, second stage could be from after college tuition payments to retirement, then retirement til eventualy death.

Institutional is easier? Or even worse?

_ Liquidity _


Net cash outflow = Benefit payments – Pension contributions Some important factors: - Proportion of retired lives relative to active lives - Size of annual Sponsor’s contributions to the plan relative to annual benefit payments - Age of workforce served by the plan - Early retirement options and/or the option of retirees to take lump-sum payments - Funded status of a plan Foundation: Anticipated cash needs (captured in a foundation’s minimum spending rate) + Unanticipated cash needs (not captured in a foundation’s minimum spending rate) – Contributions made to the foundation Life: - Pay death benefit payments - Meet demand for policy loans - Meet working capital needs etc. Some important factors: - Disintermediation - Asset-Liability mismatch - Asset marketability risk Non-life: - Unpredictable cash outflows - Underwriting and business cycles _ Time Horizon _Pension: - Going-concern DB plans versus terminated DB plans - Single stage vs. Multiple stage Foundation: - Perpetual vs. Limited time horizon Life: - Long Time Horizon (Consider - Policy surrenders (disintermediation) and/or loans - Duration of insurance products offered by the company) Non-Life: - The short time frame of the underwriting cycle that impacts the portfolio mix of taxable and tax-exempt bond holdings. - Shorter durations of casualty liabilities.

June, good writeup. Just a follow up, for the liquidity req for DB, i’ve never seen investment income tied to that formula. In other words:

Liquidity Req = Benefit Payment - Contribution

For liquidity purposes, and leaving absent the return requirement, are you sure investment flows would further reduce the stated liquidity requirement

^ You are right…I wrote too quick… Revised the post.