If there’s a future expense in the future (eg: house purchase in 4 years or some kind of spending requirement in 5 years), do we need to find the PV of this liability and remove it form the assets today? It seems that schweser sometimes like to remove it and sometimes it doesn’t (ie: the return requirement would be for today instead of 4 years from now and vice versa).
I think there’s two possible approaches. 1. Do what you said. This makes sense when the future outlay is certain in amount and timing, and not too far away. 2. Create a separate time horizon. I’ve seen them do it this way, but to me it doesn’t seem to make much sense, unless it’s far away. For example, if your house purchase is only 4 years away, you’d have to develop enough liquidity and reduce the risk to zero between now and t=4, so how much extra alpha can you generate vs throwing the whole thing into an immunized Treasury port now?
I would go with the first approach.
What discount rate will you use ? I find in some they don’t give that information.
Use Risk-Free Rate, unless otherwise stated.
I found that if the outlay is expected to happen in one year, you need to calculated PV. If it is going to occur just in 6 or 9 months, could just use the amount indicated.
So by taking the PV of the future expense say in 4 years time from now, you’re assuming that you’re going to invest that money at the risk free rate in a cash instrument correct? So when doing the asset allocation, if asked, you would allocate that PV to cash right?
That’s probably the simple answer that they’re looking for. What I would do is immunize it for the 4 years using Treasuries and get higher yield (assuming upsloping yield curve) without taking on any credit risk.