IPS return requirement when given PV, FV, N and PMT

CFA Level III Portfolio Management
#1

One of the mock question talks about an investor who has 10.2mm in account now and withdraws 55m each year for mortgage payment. He needs to have 15mm by the time he retires which is in 5 years.

I calculate the rate required 8.5% and multiply by (1+inflation) to get the nominal rate of return required but the answer just leaves it at 8.5%

Question asks for after-tax nominal rate of return that is required.

I’m sure I’m missing something simple but why don’t I need to multiply by (1+inflation)?

#2

It would help if you list the question # and which mock it came from.

#3

55000 - I believe it is the 2010 exam chuckrox.

and to answer the OP - the 55000 in mortgage expenses is a) fixed, b) usually paid with after tax money.

so when you use the 55K PMT it is after tax nominal already.

#4

Hi cpk,

I understand about the after tax part but why don’t I need to multiply by 1+inflation? In previous section it asked to calculate return, it was a simple liquidity needs/asset base so like 55K/1M = 5.5% but you have to count for inflation so the actual answer is (1.055)(1.04)-1 = 9.72%. Why do I ignore inflation for the next part?

Question is from 2008 AM Q 1 part D.

#5

if mortgage payments are fixed they do not adjust for inflation.

#6

^previous section asked for return required and it had the same mortgage payment on asset base and in that case you had to adjust for inflation

Answer

Part A)

outflow required next year (mortgage) 55K

divided by investable assets 995K = 5.53%

plus inflation 1.0553 * 1.04 = 9.75%

Part D)

mortgage payments remaining 5

annual mortgage amount 55k

PV 10.2M

FV 15M

solve for i 8.48% (why don’t I multiply this number by 1.04?)

#7

Part B is an IRR question. IRR is the rate that sets the NPV = 0. This will be a total nominal return.

Also the mortgage payments are fixed so PMT = 55k every year so that doesn’t increase with inflation.

#8

thanks, can i just assume that whenever it’s an IRR type return question, i don’t need to worry about inflation?

#9

Yes. IRR, no worry about inflation. The same as pension discount rate.

#10

Hold on…Look at Schweser B1. P237 (Example 3)

Calculate I/Y

and then

Norminal rate = I/Y + inflation rate

#11

If the mortgage payment is fixed and the terminal value is in then-year dollars (not today’s dollars), then you _ should not _ add inflation.

#12

Ah…probably L1 again. What’s then-year dollars vs. today’s dollars?

#13

I think I get it.

Today’s dollar: not consider inflation yet. (If the question asks nominal return, add it after I/Y) Future dollar: already consider inflation.