**Please help*Req. Return Calulation (inflation and taxes)

Okay I really need some help on this one and I know it will be worth a lot of points on the exam. There seems to be some conflicting data in Schweser and an answer given by CFAI 2009 essay question number #1 on the Before Tax Required Return. If you went to the three day review (I went to Chicago), slide number 29 in the book says something like this: -If a person needs 50k after tax and they have a 1million dollar portfolio. Their real return is 5%. If they are in the 35% tax bracket and inflation is 3%; their nominal tax return is (5% + 3%)/(1-.35)= 12.308% in this example. In other words, they are grossing up for taxes once inflation has been added. -CFA says that inflation is added AFTER the real return has been grossed up. In other words, 5%/(1-.35) = 7.69% + 3% = 10.69%. If anyone could help I think that this would be very helpful. I didn’t see a thread so forigive me if I am repeating here. Thanks

where in the CFA text does it say that? do you have the page number? Schweser makes sense. Let’s say your portfolio’s return is 10.69% this year. 10.69% * (1-0.35) = 6.95%

I agree with Schweser. That is the only way you can ensure that the after-tax amount you have left is sufficient to cover both spending need and inflation

yeah, on what page in CFAI is the info you gave? Because 12.308* (1-.35) = 8.0002, which would be correct.

I agree with Schweser as well. The investor will eventually have to pay the capital gain tax for both the growth for spending need and inflation portions of his/her portfolio. Actually even CFA text mentions briefly as well. Please read the thread below: http://www.analystforum.com/phorums/read.php?13,1131550 I sent an inquiry to CFAI 2 weeks ago. They replied me quickly that someone from education dept. will contact me soon. However, I haven’t heard anything since. I will post the result once receives.

Thank you all for your feedback. The CFAI data was from 2009 Essay question #1. Nonetheless I sent an e-mail to Greg Filbeck the CFA Level II Schweser instructor and here is his response. “On the exam you should gross up real return and then add inflation. While i think they would accept either answer. We always go with the more recent example.” I hope this helps us all… Good luck studying…

Just bringing this back up as it seems to gross up the return for tax after including inflation… CFAI Book 2 page 131 at the bottom… It says her 3% real return after tax implies a gross total return pre tax of 10.8%… tax rate is 35%… and inflation was 4%… (.03 + .04) / (1-.35) = 10.8… looks like to find the nominal return before grossing up for pre tax…

this is the kind of thing that I am talking about. Schweser says one thing via their 3 day review (slide #29), 2009 ESSAY CFAI test question #1 says another, and CFAI 2010 books says what what boston21 posted. If they accept either I guess I won’t give it much attention any more. I may just write down both answers and say that inflation was added after in the 2009 essay question and inflation was added before in the 2010 CFAI curriculum. Let’s see how they like them apples…good luck with the books.

the fundamental solution would be to use GEOMETRIC calculation guys. normally both arithmatic and geometric are accepted, but geometric is more preferred everywhere. so if use geometric, pre tax would be (1+5%)(1+3%)/(1-35%) - 1= … after tax would be [1+[(1+5%)/(1-35%) - 1]]*(1+3%) - 1 they equal with each other, doesn’t it

James at houston - did you ever recieve anything back from CFAI? I would rather hear from them since it is they are even showing it both ways (last years test vs. this years book 2).

Please follow this thread to see the CFAI response. http://www.analystforum.com/phorums/read.php?13,1131550 I still think there is some problem with CFAI’s answer on 09 exam that it is a deferred tax account. I think the investor will eventually have to pay the capital gain tax for the growth of inflation portions of his/her portfolio (as I mentioned before) even though the tax will be deferred in the future. It doesn’t make sense that when the investor/his heir finally take all the money out and pay the deferred tax; then he would find out the portfolio’s growth has lagged the 4% inflation and lost real value. Am I missing something? Nevertheless, that is the CFAI answer. We have to follow in its exam.

mingo54, fyi if you put down 2 answers on the test then you are guaranteed zero points. ndzhai, the CFAI accepts either geometric or arithmetic… who cares. James@, I think you’re calculating for the portfolio’s entire duration, where as the CFAI asked for only the 1st year. Anyway, it’s highly likely they accepted both answers last year…


charlottekid Wrote: ------------------------------------------------------- > BUMP Just egging them on??? ha

sct123 Wrote: ------------------------------------------------------- > charlottekid Wrote: > -------------------------------------------------- > ----- > > BUMP > > Just egging them on??? ha Exactly. But they needn’t worry as Level II was the hardest level.