2016 essay exam -6C

CFA Level III Portfolio Management
#1

In 2016 exam, Question 6C, I do not get why we had to get the monthly return and annualize it. why did not we get the annual return right away?

The answer is presented below.

Calculate the minimum annual after-tax return required for the Mattisons to be able to retire in 10 years, assuming Greer’s assumptions are correct.

Note: Assume all cash flows occur at month-end.

Step 1: The current value of the Mattisons’ first home is EUR 290,000 and it is expected to appreciate 3% per year for the next 10 years. Therefore, the future value of their first home is: Present value (PV) : (EUR 290,000) Expected rate of return (i) : 3% Number of years (n) : 10 years Solve for : Future value (FV) : EUR 389,736 OR FV = 290,000 x (1.03)10 = EUR 389,736 The future value of the first home is deducted from the ending portfolio value indicated by Greer: EUR 3,000,000 – EUR 389,736 = EUR 2,610,264 The Mattisons’ investment portfolio will need to grow from a starting value of EUR 700,000 to an adjusted ending value of EUR 2,610,264 in 10 years.

Step 2: The Mattisons would need to earn an annual after-tax investment return of 7.81% (or 8.09%) in order to be able to retire in ten years. Present value (PV) : (EUR 700,000) Savings (PMT) : (EUR 72,000) ÷ 12 = (EUR 6,000) per month Future value (FV) : EUR 2,610,264 Number of periods (n) : 10 years x 12 months = 120 months

Solve for : Expected rate of return (i) : 0.6506% (monthly) Annualized after-tax return: 0.65% x 12 = 7.80% or 0.6506% x 12 = 7.81% or 1.006512 – 1 = 8.09%

#2

Because they wanted a more precise number.

The question said " Note: Assume all cash flows occur at month-end."

Do you spend money once per month or do you spend money once per year? This question asks you to do the calculation once per month.

In real life, maybe you spend money once per day… we do calculations usually on monthly budget or annual budget. The more granuilar you get, the more precise the number will be but the more complicated it gets.

#3

Thanks!

#4

When do we know if they want the calculation annually rather than annualizing the monthly returns?

#5

When they tell you to consider payments as _end-of- year _ cash flows.

#6

Because theu will give different results.

#7

Because they will give different results.

#8

Thanks!