Return Objectives and Liquidity Req't (Individual & Instiutional)

CFA Level III Portfolio Management
#1

Hello everyone!

I want to get something straight last minute. When asked to prepare the return objective in an individual IPS, we would normally add salary/retirement income to reduce the person’s required cashflows right, which is then used to calculate the required return.

So moving on to liquidity requirement, do we use this same salary (inflation adjusted in year 2) to calculate liquidity? I understand we have to add regular living expenses and one-offs etc into this, but I want to get the “adding the salary” part right.

Last question - are these calculated the same way in an institutional IPS? ie. a Foundation receiving annual donations of $1M. Is this $1M to be used to reduce required cashflows in calculating the return objective? Also is this used as a positive inflow to reduce liquidity requirement?

I think I have seen questions where they have ignored salary/contributions in calculating the above.

Thank you everyone!

#2

anyone can shed some light?

#3

From what I remember from the practice exams, they do it both ways.

I think the default behavior is to use incoming cashflow to offset liquidity requirements. The exceptions to this rule seemed to have statements such as “Benefits are directly deposited into the account and automatically invested” - so incoming “cashflow” still needed to be sold for liquidity.

Now that you’ve asked this question I’m not entirely certain of the answer so I’ll take another look later.

#4

thanks - ya i agree with adding regular salary and contributions for return objectives and liquidity requirements as well. It doesn’t make sense not to add them - just that i’ve seen questions where they were not added and DID NOT explain why.

#5

If the savings are deposited directly in an account, then you need to remove them from liquidity netting, because it’s now part of the portfolio.

#6

It really depends on the situation. If the individual is a net-saver (earn more money then they spend) then don’t include it in the liquidity requirement since they can pay for expenses out of pocket (i.e. portfolio does not need to be liquidated).

#7

If he is a net saver beyond normal expenses, but has other expenses, regardless their size, it’s included in the liquidity requirement.

He has to actually deposit that net income saving though. I think it was in 2013 AM.

#8

Can someone explain this to me again.

#9

As Mr Smart said above…I think if it states that savings are immediatley invested/added to the investment portfolio, then they become part of that portfolio and it’s a liquidty event to get them out.

#10

Correct. If they are invested immediately then it is part of asset base and a liquidity requirement on all withdrawals.