2009 Exam Retail - Patricia and Alexander Tracy - Liquidity constraint.

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Little confused with the liquidity constraint question. Got everything else. Question goes:
Prepare the current(2009) liquidity constraint for the Tracy’s IPS:
i. if they retire at age 60.
ii. if they retire at age 65.
In 2009 the tracy’s are 59 years old and they’re income = expenses. The solution explicitly states right at the beginning that in 2009, the year before retirement the tracy’s have no liquidity constraint.
That’s ALL i would’ve put in the solution for both answers. The CURRENT liquidity constraint in either case is ZERO regardless of when they retire and the question is asking for the current liquidity constraint.
If the question stated, what is the tracy’s liquidity constraint when they’re 60 and when they’re 65, what is it at those times —> I would’ve followed their solutions.
Thanks.
 
Hello Cipherap15,
Let me see if I can help. This is the 2009 Level III exam. An IPS is a forward looking policy for management of the client’s objective (risk and return) and the five constraints, as this question part C focuses on the liquidity constraint.
You are correct the Tracy’s are age 59 at the start of the reading and thus between 59 and 60 have no liquidity constraint as the question mentions. As although the question reads “prepare the current (2009) liquidity constrain for the Tracy’s IPS …if they retire at age 60” its at the age 60 they want your solution not at age 59 or currently for which they have none.
If you look at the third paragraph below exhibit 1 you’ll see “Brisco determines…” and the second sentence states…”If they retire at age 60, they plan to payoff their mortgage and associate taxes by withdrawing CAD 1000,000 from the portfolio upon retirement” (at age 60 added for emphasis). Additionally they will need liquidity to pay first year retirement expenses of 45,000 (= after tax pension income 80,000 less after tax annual expenses 125,000). Therefore the liquidity constraint if they retire at age 60 would be CAD 100,000 + CAD 45,000 for a total of CAD 145,000.
The same holds for the second part of the question 1Dii.
I hope that helps clear that up, if not let me know and I’ll try again.
Marc A. LeFebvre, CFA
President & Founder - LevelUp, LLC and LevelUp BootCamps
www.levelupbootcamps.com
 
This is how you read it: stated it above
if they retire at age 60. ”its at the age 60 they want your solution not at age 59 or currently for which they have none.”
Lets look at this from age 65 and use your wording.
“if they retire at age 65” its at the age 65 they want your solution not at age 59 or currently for which they have none.
If we read it as you did, then the liquidity constraint would be zero at age 65. On the exam paper on the second page it says “The arrangement covering both sons, would require the Tracy’s to make a single payment of 200,000 at age 60”.
In the solutions for liquidity needs at age 65, they say the liquidity constraint in one years time at age 60 is 250,000 = 200,000/(1 - 0.2).
This is how I see it and understand it now. You just keep moving forward from 59 and mention all the liquidity constraints that come about after that year for the two different cases. Don’t do the current liquidity requirement at that age as you mentioned above.
I think you always look at age 59 and just keep moving forward year after year and mention all the liquidity requirements. For part b(retiring at age 65), I would say,” the current liquidity requirement is zero, in ones year time it is $250,000 (Negative liquidity event) and it has no ongoing liquidity constraints after that”
 
The Tracys are 59
If the Tracys retire in 1 year at age 60 the pension income will be CAD 45,000 less than expenses, plus they desire to pay the mortgage of CAD 100,000 for total liquidity of CAD 145,000 needed in 1 year from now.
If the Tracys retire at age 65, their pension income grows to almost meet expenses and in this case the Tracys would need to pay tuition from the portfolio of CAD 200,000. In this care the liquidity required in 6 years from now would be CAD 200,000.
So what you “said” above is correct just be clear as I did above when answering the question and PLEASE make sure you label the solution CAD.
Marc
 
The Canadian dollar, Australian dollar and United States dollar all use the $ symbol. Since the Tracys live in Canada and they asked for a liquidity amount please label it as CAD, you could lose an easy point on the exam and I would hate after all this focus to lose that easy point. It has been an issue on many an exam ;-) And your more than welcome, anytime.
 
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