IPS - Individual - Liquidity Constraint

  • Net ongoing cash flow

  • One time expense

Do we need to include " Home" into IPS - liquidity part?

In what sense?

Home is illiquid asset?

The liquidity constraint lists cash flow needs.

It’s not intended to list illiquid assets.

(If it were, in addition to your home you would have to list private equity or hedge fund investments, concentrated positions, family businesses, and so on. But that’s not the idea of the liquidity constraint.)

Schweser B1. P227

Clients’ needs for liquidity include:

• Ongoing, anticipated needs for distributions such as living expenses. • Emergency reserves for unanticipated distributions could be appropriate if clien specific and agreed to in advance. Otherwise they create a “cash drag” on portfolio return by continually holding assets in lower return cash equivalents. Holding three months to one year of the annual distribution in cash reserves could be reasonable if agreed to in advance. • One-time or infrequent negative liquidity events requiring irregular distributions should be noted. Be as specific as possible as to when and how much is needed. • Positive liquidity inflows not due to the portfolio assets should also be noted. • Illiquid assets, such as those restricted from sale or those on which a large tax billwould be due on sale, should be noted.

Well, I learned something new today.

I’ve never seen illiquid assets listed in the liquidity constraint section in CFA Institute’s guideline answers to the actual AM exams, but you’re quite correct: it is mentioned in the curriculum.

They are, however, quite vague about what to do about one’s home. As they had ample opportunity to mention specifically that it should be included and never did so, and as I’ve never seen it listed in any guideline answer, I feel safe in saying that you need not include it.

Thanks, June!

Thanks S2000.

My pleasure!

What about positive liquidity events (ex. John will get an inheritance in 3 weeks time)?

What about stating the total liquiidty on a net basis (John saves $20K a year, and this year will be paying off his outstanding debts of 35K, so I find myself answering the liquidity event = $35K - $20K = $15K). However, its rarely the correct answer.

In general, I find this constraint to be not as straight forward as it should be:

Either I writie too many liquidity events (ongoing, far into future needs, ect) and/or incorrectly stating the liquiidity on a net liquidity basis.

Does anyone have any tips on how to simplify this slow witted man?

Yes, positve liquidty events needs to include. For example, 2013 CFA AM - annual saving.