2013 CFAI AM Q6 Part C

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mjtwo3

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Why is inflation not factored in the liquidity requirement for year 2?
 
Inflation is not part of the liquidy requirement, it is only considered in required return to preserve real value of portfolio. So you’re not spending the inflation rate, your using the spending rate to determine liquidity need (nominal value of portfolio * spending rate = year 2 spending
 
I think the reason could be slightly different - the inflation refers to the university’s operating expenses. While the foundation is supposed to support it, the deal is only to pay in 6% of the foundation’s MV - in other words while it is important for the foundation’s required return calc, it is not really a liquidity issue for the foundation.
I had the same mistake and also said “wtf” when I saw the guideline answer:)
 
Thanks for the quick reply. Makes sense. I factored inflation in because they did in Q1 part C for an individual. Increased expenses by inflation for the current year to figure out part of the liquidity calc. Why question 1 and not 6?
 
because in q1 (individual) the inflation-adjusted spending is your real requirement - this year you spend 300k and next year it’s 300*(1.025) - you simply MUST add this amount to liquidity needs because your liquidity = cash expense, an actual outfolw.
in q6 (foundation) on the other hand it is the university, not the foundation itself (who manages the portfolio) who is affected by inflation. So the foundation should grow its portfolio (return requirement) by 6% plus inflation plus fees. The return requirement already assumes there is a 3.5 inflation. If all is ok and you make this money each year then naturally your foundation MV grows each year by a % which already includes that 3.5% inflation - hence your 6% spending already includes university inflation.
does it make sense?
 
no worries - I actually only really understood that when I thought I would answer your question
 
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