Reading 10 - IPS - How to deal with inflation

Elliotbay

The question I have is in regard to Christa’s return requirement; this is in reading 10, questions 1-8.

Christa’s expected return for the portfolio is said to be €82,500, which in the solution is said to include inflation. However, it says her expenses will be €100,000 (or €50,000 more than art sales) which the solution assumes does not include inflation.

How are we to know if a number includes inflation or not? In other words, why are we to assume that her investment return includes inflation and her expenses do not include inflation?

cfa10yrplan

I just want to say "welcome to level 3".

pawn

LOL oldboy.....

Ah Christa and her out of wedlock child and her scumbag drunk driving brother. I almost miss them.

You have to pay attention to everything said in those case studies. For example, if they say expenses are 100k next year, that's what they are. If they say were 100k this year and will grow at inflation use that. If they say inflation is 3% but is 5% for art materials and studio space, use 5%.

You really have to watch the temporal aspect...when will art sales be 50k, this year or last? When are expenses going to be 100k? Etc etc etc.

Then of course you have to also hit the principle with an inflation protecting return...Always what, children? ALWAYS PROTECT THE PRINICIPLE.

Good luck man.... As oldboy said, welcome to level iii.



Edited 1 time(s). Last edit at Wednesday, September 7, 2011 at 06:48AM by ElDeathMachine.

IAmNeil

Expenses/capital --> Real required return --> + inflation --> Nominal return
(Expenses + Inflation adjustment) / capital --> Nominal return

So adding inflation to real required return or adding inflation adjustment to expenses to arrive at required return both give you the same nominal required return. In other words, expenses and real required return are one and the same, its the amount you withdraw from your investments every year.