IPS-Required Return calc?

CFAR Vol 2, page 202, Question # 11 (the muellers) why do we not calculate the required return as of today, when their Daughter goes to school? In the Answer, they calculate/determine the required return as of 10 yrs from now (i.e. when they retire.) can anyone explain as to why? I would think one would need to calculate the required return as of the first Time Horizon (i.e. when the daughter goes to school) what is the process for determining as of when to calculate the required return? I mean other then it being stated specifically in the question. i.e. “calculate the required return as of retirement.” thank you, a

I haven´t done many exercises yet, but it seems they always take the date when you stop receiving your regular income (usually salary). You calculate your expenses at that time (usually your current expenses adjusted by inflation as years pass) and, dividing them by your assets, you get the return necessary to be able to pay those expenses

-Hala- That’s an interesting point…I will definately look at that when approaching these questions. It makes sense in the fact that, an individual would need to focus on what return they need from their portfolio when their is no salary to compensate them. Hence, “Income” now needs to come from somewhere else. i.e. primarily the portfolio. Thanks H! Anyone else concur with this? other opinions?

Actually the “required return that considers the daughter going to school” is covered in the liquidity part (2.7%). I have another question though: in part (B). Why is portfolio A preferred? A point from solution is that “intermediate-term fixed income … is warranted”. Can sb explain a bit more? - sticky

well, may be Hala is right. But I thought it’s CFA’s mistake because the way CFA questions are stuctured is the information we need to answer the question should be beyond the question. and here we have pension income and expenses details formulated after Question A. Also as I remember Schweser instructs us to calculate return requirement only for the first period (although Schweser has less authority there is no any guidance on this issue in CFA Reading 15). Regarding Part B the logic is as follow: none of the portfolio satisfies return requirement (~10% after-tax), but as Muellers don’t object if the principal is invaded we just choose portfolio providing more comfort terms for financing living expenses (cash reserve, intermediate fixed-income, small portion of equity)

It seems from question B that the CFAI was not as concerned with meeting a return objective given the short time horizon (both Muellers dying - grim). Therefore liquidity concerns dominate and an intermediate-term fixed income portfolio will generate steady income. For Portfolio C, though, I don’t know why CFAI states the required return is 5.4% [Volume 2 Page 203]. That is the after-tax return and doesn’t take inflation into account. Is there a logical explanation, or is this a CFAI oversight?? In other examples we have gross up for taxes and adjust for inflation. Why is this case different?

I was just going through this and both B and C absolutely killed me. I just don’t get the way CFAI thinks about these questions. Take part C. The 5.4% return requirement comes from the need to grow the trust assets from $2MM to $2.6 MM in five years (and is actually given explicitly in the problem). Okay, so we have a return requirement and we’re told that the only concern is that they meet that return. Sounds to me like a job for shortfall risk… But no… If you calculate a safety-first ratio on each of the portfolios using E® - 5.4/StDev, you get A: -0.2, B: 0.05, C: 0.16, D: 0.17. Based on that, I was sitting there focusing on C and D, ultimately picking D because it had no unnecessary allocation to cash. But NO, CFAI says portfolio B is the best. Yup, the one with the highest risk of shortfall among the portfolios that meet the return requirement. Welcome to bizarro world. I think I need to find a way just to show up for the afternoon section. Lots of potential advantages: I’d miss all the IPS questions which are sure to make my head explode and put me in a bad frame of mind for the afternoon, and, even better, I’d get to sleep in. Or maybe I can show up for the morning, not open the book, and just kick back and nap for three hours… Hmmm…

yeah. if you picked a wrong portfolio but your logic was more or less credit, do you get any credit. These questions are like a lottery, if you get them write you go all the away, else you may get a Zero.

yeah. if you picked a wrong portfolio but your logic was more or less credit, do you get any credit. These questions are like a lottery, if you get them right you go all the away, else you may get a Zero.