I know there is more than one thread on this, I just want to clarify it in a simple format. Simple question, calculate pre-tax return on portfolio recommended: Post-tax required return = 5% Inflation = 2% Applicable tax rate = 25% (No costs or anything else). Answer 1: Inflation assumed tax-free, arithmetic compound Pre-tax return = 5% / (1 - 25%) + 2% = 8.67% Answer 2: Inflation assumed tax-free, geometric compound Pre-tax return = [1 + 5% / (1 - 25%)]*(1 + 2%) - 1 = 8.8% Answer 3: Inflation not tax free, arithmetic compound Pre-tax return = (5% + 2%) / (1 - 25%) = 9.33% Answer 4: Inflation not tax free, geometric compound Pre-tax return = [(1+5%)(1+2%) -1]/ (1 - 25%) = 9.45% It is the exam RIGHT now. Its an IPS question. Which are you ACTUALLY putting down, 1, 2, 3, or 4?
i am doing 3… but what do I know…
#3 is the way i do it. good question.
#3 for me as well
Why nobody choses geometric compounding? Also, what if we’re told that capital gains are not taxed? What would you choose then?
if capital gains are not taxed it better be an all stock portfolio otherwise that question is bs. as for geometic compounding i’ve found that the cfai uses it for some problems and others it doesn’t. very confusing.
i use 4. it makes sense to me because the return itself is subject to inflation (this is similar to the currency contribution risk in SS17). i’m not a die hard believer in this, but i think it’s logical. it also gives you the highest return, which is consistent with the conservative nature of the PM. i don’t consider the arithmetic method wrong though.
i have to admit i was going with #4 in practice, theoretically its the most correct, but who gives a damn, we only care about marks here! But then i got very scared by the subsequent question being calculating a corner portfolio etc, which basically was a double jeaopardy. I have a hard time imaginging that the grader’s answer sheet includes several correct answers for several subsequent parts in a question!
>if capital gains are not taxed it better be an all stock portfolio otherwise that question is bs. in 2005 exam capital gains were not taxed…
>elem100 >I have a hard time imaginging that the grader’s answer sheet includes several correct >answers for several subsequent parts in a question! Well, again, in 2005 exam they show three different calculations for corner portfolio weights depending on whether you choose arithmetic compounding, geometric compounding and even how you rounded!
tanyusha Wrote: ------------------------------------------------------- > >if capital gains are not taxed it better be an > all stock portfolio otherwise that question is > bs. > in 2005 exam capital gains were not taxed… did it tell you what % was bonds and stocks? otherwise i wouldn’t factor in taxes at all.
tanyusha Wrote: ------------------------------------------------------- > >elem100 > >I have a hard time imaginging that the grader’s > answer sheet includes several correct >answers for > several subsequent parts in a question! > Well, again, in 2005 exam they show three > different calculations for corner portfolio > weights depending on whether you choose arithmetic > compounding, geometric compounding and even how > you rounded! i can’t believe they would take points off if you do geometric rather than arithmetic.
for the initial question (if something like this shows up on the exam) I am going with #3. In reality #4 is more accurate way of doing it, but since there is a chance of messing up subsequent questionjs (by picking wrong return) like selecting appropriate asset allocation and/or corner portfolios, #3 should be a safer option. CFAI seems to admit (through all of the practice questions we seen from them) that arithmetic compounding is ok with them.
tanyusha Wrote: ------------------------------------------------------- > Why nobody choses geometric compounding? Also, > what if we’re told that capital gains are not > taxed? What would you choose then? In 05, the CG weren’t taxed, but the methodology to solve for RR in that problem was to approach each piece separately, applying taxes where appropriate, to come up with an expense amount and then an after-tax real return. They add inflation at the end. If some parts of the portfolio are taxed and some aren’t, you can’t really use the (r + i)/(1-t) form to solve for RR.
volkovv Wrote: ------------------------------------------------------- > for the initial question (if something like this > shows up on the exam) I am going with #3. > > In reality #4 is more accurate way of doing it, > but since there is a chance of messing up > subsequent questionjs (by picking wrong return) > like selecting appropriate asset allocation and/or > corner portfolios, #3 should be a safer option. > CFAI seems to admit (through all of the practice > questions we seen from them) that arithmetic > compounding is ok with them. good call. nobody likes double jeopardy.
It takes 5 secs to calc both and label them…“ARITH” or “GEO” . (#3-#4) - I’m sure the CFA will get the drift… If its a multiple choice answer, Im going to try both and see if one shows up - if they BOTH do, Im going geometric (since it was an example in the text). If neither do, I’m guessing ‘C’
hezagenius, good point.
Has anyone checked the guideline answers for the most recent exams, like the REAL ones? I’ve only done 2005 and 2006, but in both cases I believe the question called for the after-tax nominal return. The guideline answers added on inflation, if I remember correctly, but I also think they showed the multiplicative, which was also acceptable.
So it seems the consensus is either #3 or the more theoretically correct but dangerous (from a double jeaopardy standpoint) #4. So we’re all agreed that inflation faces tax too. I guess thats the main point.
if you show your calculations, can’t all 4 be graded correctly? we’ve all seen examples that used different methods. btw, do you only calculate before-tax return if they ask you? is the default option after-tax?