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Estate Planning – pg 152 (Solutions section)

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    • Avatar of adossa3adossa3
      Participant
        28 Mar 2018 at 11:14 pm
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        Hi there,
        trouble with below answer:

        ‘It is not appropriate to use the expected return of the assets used to fund spending needs to calculate the capitalized value of their core capital needs, because the risk of the Pearsalls’ spending needs is unrelated to the risk of the investment portfolio used to fund those needs. (understood) Although the annual spending cash flows are not riskless, a risk-free rate should be used to calculate the present value of the cash flows as their uncertainty is unrelated to market risk factors that would be priced in a normal asset pricing model, making their beta equal to zero. (didnt understand this sentence)’

        Thanks very much.

      • Avatar of adossa3adossa3
        Participant
          01 Apr 2018 at 9:53 am
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          Thanks very much for your clarification – much appreciated.

        • Avatar of adossa3adossa3
          Participant
            01 Apr 2018 at 9:52 am
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            Hi there,
            trouble with below answer:

            ‘It is not appropriate to use the expected return of the assets used to fund spending needs to calculate the capitalized value of their core capital needs, because the risk of the Pearsalls’ spending needs is unrelated to the risk of the investment portfolio used to fund those needs. (understood) Although the annual spending cash flows are not riskless, a risk-free rate should be used to calculate the present value of the cash flows as their uncertainty is unrelated to market risk factors that would be priced in a normal asset pricing model, making their beta equal to zero. (didnt understand this sentence)’

            Thanks very much.

          • Avatar of ustbookmarketustbookmarket
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              • CFA Level 3
              01 Apr 2018 at 8:30 am
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              Risk-free rate should be used because from the name itself risk free, meaning it is free from market risk factors. The best measurement of market risk is Beta. And the Beta of a risk free asset is 0. You just need to match the spending needs characteristic with the discount rate characteristic.

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