Institutional Investors geometric return calculation

CFA Level III Portfolio Management
#1

I have a question relating to the Kaplan Revision Q&A book (if anyone has it - it’s the Institutional Investors question 2 part A):

The relevant case facts are as follows:

  • Private foundation (therefore 5% minimum spend requirement)

  • Set up to award grants to students to aid them with their postgraduate course fees (young string players)

  • Was set - up by Joshua Perlstein - he has signed over certain royalties he earns to the trust that amount to 0.9% of the trust’s value per annum

  • Average fees for postgrad courses are forecasted to rise at c.3.3% per annum (3.1% is inflation, but these rates are both for the long term. Therefore the 3.3% already accounts for inflation)

  • Investment management fees are 0.72% per annum

Based on this, I calculated the return requirement as:

(1+5%)(1+0.72%)(1-0.9%)(1+3.3%) - 1 = c. 8.26%

The answers show it as:

(1+5%)(1+0.72%)(1+3.3%) - 1 = 9.25%, and then accounts for the fact that 0.9% royalties reduce return required —> 9.25% - 0.9% = 8.35%

Is what I did (including the reduction in the geometric calc) wrong, or would it still be considered correct?

Any help would be appreciated,

Thanks

#2

Anyone?

#3

the numbers are pretty close together.

in addition, when I did a cfai mock exam, both approaches (arithmetic vs geometric) is acceptable as long as it’s not stated (question will state which method to use if any)

#4

Thank you for your help.

I was a bit more confused as their answer is a combination of both geometric and arithmetic, rather than one or the other. I won’t spend time dwelling on it, but just wasn’t sure if I was missing something more crucial!

Thanks,