I used nominal risk free rate to calculate Present Value, the answer used Real risk free rate. Why? Mad Are future spending not already adjusted for inflation?
Where’s the problem you worked?
2015 practice vol2 Exam 2 AM question 8a
I haven’t checked again this problem raised by suspense. But I have this same bothering question and it seems unanswered on this forum. Or I haven’t seen one concrete answer.
The solution to all questions on (individual PM) required rate of return always lead to real rate while they use nominal CF (spending increased with inflation). Then they solve nominal rate by adding inflation. Is this different from what we know that nominal discount rate is used with nominal CF? Could anyone help with this?
Below is taken from CFAI text (reading 11, section 3.1, first paragraph).
The amount of core capital needed to maintain an investor’s lifestyle in a probabilistic sense can be estimated in a number of ways. First, it is important to incorporate the effects of inflation, particularly over long time horizons. One can either forecast nominal spending needs discounting them to the present values using nominal discount rates, or forecast real spending needs discounting them using real discount rates. The two approaches are indistinguishable.
Also look at reading 11, blue box example 4 part 2
Thanks.
So either can be used:
Nominal spending needs discounted at nominal discount rates
Real spending needs discounted real discount rates
Let me sound stupid. is the yearly increase in annual spending not an inflation adjustment?