Rd 12 page 436 - in the middle of the page, the calculation for the adjusted rate confuses me. Why the discount rate is in the numerator and growth rate in the denominator? Usually growth rate is in numerator???..
Can anyone explain this to me?
This is basically a real return calculated using the geometric method, i.e. (1+r)/(1+g)-1. The arithmetic method would simply be r - g. You subtract growth from the nominal discount rate to account for future inflation. It’s the same thing as calculating required nominal return by first calculating real return and then add inflation either via (1+r)*(1+g)-1 or r+g.
Thanks. Can you elaborate with an example please?
Also, Eoc # 15- calculations do not include cash Values? We need to deduct that from total cost- don’t we?
Ok so as an example in IPS form: say there is a list of inflows and outflows and you need to calculate the return requirement, you take the net need and divide it by the asset base. This is your real return assuming that the in and outflows will stay the same in today’s dollars. Then if the question asks for nominal return you add inflation right?
You can then either simply do R + G (G or I, both the same either inflation or growth in value) or do (1+R) x (1+G) -1. First one is arithmetic and second is geometric. The values should be quite close to each other. In the aforementioned case they deduct inflation because they started with a nominal return and were dealing with real in and outflows.
EoC #15 asks for net payment cost index which doesn’t use cash value, that’s the net surrender cost index.