How to Deal with This IPS Situation?

[Audacious]

Investment Base 1000
Scenario 1:
Outflow : annual expenses of 100, will raise with inflation
inflow : annuities of 30 , inflation indexed
scenario 2:
Outflow : annual expenses of 100, will raise with inflation
inflow : annuities of 30 , NOT indexed to inflation
How to define Return Objectives for both scenarios?
I know the math behind it, but I dunno what CFAI expect as sometimes they go with a simplified answer.

 

[arigolden]

*will RISE with inflation.
I think you need a little more info to come up with a CFAI type Return objective. I did a similar type question last night where the question clearly tells you that your cash inflow will hedge any increases in expenses going forward. (EOC Q12 or 13 in the private wealth curriculum - I forget the page). Based on that here is my two cents:
Scenario 1: your expenses increase with inflation, and so too does your income (as it is indexed to inflation). However this just means that you are hedged for inflation so you do not need to add inflation to your return requirement. You still suffer from shortfall risk as your expenses > income so your return objective should be to generate enough return to meet living expenses etc. So lets say you computed a 3% return, that is your return requirement. I would also write a bit more on the need for income being greater than the need for growth, especially given that the investor will have to rely alot more on the portfolio income to meet his living expenses.
Scenario 2: your expenses will rise with inflation but your income will not. Obviously you have to ensure that you generate a return that incorporates inflation in this scenario. Given that you still suffer from shortfall risk and now inflation as well your return objective should mention something about generating income after taking into account the effect of inflation. So lets say return of 3% and inflation is 2% so 1.03 * 1.02 -1 = 5.06% total nominal return requirement + all the other qualitative stuff from scenario 1.
Check Q12 and Q13, they are excellent concept builders although I do agree that sometimes the CFA answers are extremely detailed, and sometimes just a few points.

 

[Audacious]

arigolden wrote:
I do agree that sometimes the CFA answers are extremely detailed, and sometimes just a few points.

this is the part that am worried about. I’m not sure about their tolerance on differing minor interpretations or approaches. Number of minutes might be a good guideline on the expected level of details . But when it comes to calculations, what can be solved in 2 minutes by some, takes 6 minutes by others.
CFA veterans should know better

 

[arigolden]

I agree, Q12 that I mentioned for example didnt really use any calculations in the return objective - just lots of words. Hopefully S2000 or CPK can provide some guidance.