Preserve purchasing power and the household income engine

Learning goals

• Diagnose the case using the stated constraints and quantitative evidence.
• Defend a conditional decision and identify what further evidence could reverse it.

Draft · approximately 95 minutes, excluding further revision.

Decision case · fictional facts

A professional earns 200,000 annually but could lose income through disability. The household’s living costs are 80,000 today, with planning inflation 3%.A child’s foreign tuition is 100,000 units of currency F due next year; today 1 F costs 1.10 domestic currency. The domestic-per-F exchange quote could rise 10%.

Human capital has insurable and correlated risks

Death, disability, illness, job loss and occupational concentration affect future earnings. The suitable mix of insurance, reserves, retraining and diversification depends on dependents, benefits, contract terms and affordability. A portfolio heavily invested in the employer or industry may fall when labor income also weakens; insurance exclusions and claims conditions need actual contract review.

Nominal capital can lose real value

Inflation raises goal costs and can erode fixed nominal claims. Use real after-tax returns and liability-linked cash flows where suitable; equities, real assets and inflation-linked bonds each have distinct valuation, tax and basis risks. No asset perfectly hedges every personal spending basket or inflation shock.

Currency should follow future obligations

Foreign spending creates a liability even if all investments are domestic. A matching currency deposit or an appropriately implemented forward can reduce nominal FX uncertainty, but has cost, counterparty, collateral or opportunity trade-offs. Hedge size and maturity should follow the goal; do not turn a tuition hedge into a speculative currency position.

Separate an exchange-rate hedge from an affordability plan

Fictional tuition extension: 100,000 units of F are due in one year. Spot is 1.10 domestic per F; an available forward quote is 1.12 domestic per F with no upfront premium in this simplified example. At maturity, compare an unhedged payment with a long-F forward hedge under spot outcomes 1.21 and 0.99. Ignore credit charges, collateral and bid–ask costs for the numerical comparison only.

The household can set aside only 105,000 domestic now. Explain whether fixing the currency price at 112,000 by itself solves the funding problem. The forward fixes a price under its terms; it is not a free source of the 112,000 settlement funding.

Model reasoning, sensitivity and self-check

The fixed contractual tuition funding amount is 100,000×1.12=112,000 domestic. If spot is 1.21, unhedged cost is 121,000 and the forward position offsets 9,000 of adverse currency movement. If spot is 0.99, unhedged cost is 99,000 and the hedge sacrifices 13,000 of favorable movement relative to remaining unhedged. The hedged cost is still 112,000 under the simplified assumptions.

Starting with 105,000, the household would require 112,000/105,000−1 = 6.6667% one-year growth before any costs to fund the forward settlement from that amount alone. This is a required financing hurdle, not an achievable promised return. If a safely matched reserve cannot meet it, revise savings, timing or the goal rather than assert that FX hedging has made tuition affordable.

Self-check: use domestic-per-F consistently, state the F amount and deadline, and distinguish certainty of price from certainty of counterparty performance and cash availability. In implementation, assess collateral, settlement conventions and whether the goal itself could change. Insurance against loss of earning capacity addresses a different household risk.

Formula and assumptions

Future cost=current cost×(1+inflation)^T;domestic liability=foreign amount×domestic-per-foreign FX

Errors to catch

• Confusing currency depreciation with a fixed percentage rise in every exchange quote.

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Original knowledge check

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Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.

• Reference · www.investor.gov
• Reference · www.investor.gov
• Reference · www.cfainstitute.org