How the CFA L3 Tests Return Objectives and Calculations

So let's start with return. Return has two parts--the return objective and the the return requirement. As you can see, both are directly tested on the CFA Level 3 exam:

Return Objectives - CFA L3

This type of "12" minute problem will appear after a long passage that lists a lot of attributes about the investor and their situation. It appears to be a fairly straightforward problem (and in some respects it is), but (1) it can be a time suck if you haven't adequately prepared and (2) there's a lot of tricks that the CFA Institute tries to throw into these problems to trip you up.

Let's start with the basics and then dive into the tips and tricks.

The Return Objective

The first is the return objective which is literally a statement of the investor's objectives.

For example:

  • I would like to buy into my law firm's partnership with $500,000 in 10 years when I'm eligible to make partner
  • I would like to meet my living expenses
  • I would like to pay off my mortgage
  • I would like to preserve the real value of my portfolio

In addition to being directly tested, return objectives set the parameter for how much money an investor will need future value or future time period.

Required Return on the Investment Policy Statement

The second part is the required return. This is the calculation where you take the objectives and back into what the return is that's needed to meet them. In other words the return requirement is framed as a required return to meet essential objectives.

It's usually worth 6 to 12 points on its own. Ultimately what this boils down to is a time value of money question which we've seen on all three CFA levels.

Calculating Required return - CFA l3

What makes it tricky here is that you're:

  1. Picking out all of the details from a long passage
  2. Have to factor in inflation and tax concerns if you're calculating nominal pre or post tax return

In the end the best way to get comfortable with the tricks is to practice these problems over and over again. 

Steps for solving required return- Method 1

So what are the steps for solving required return? There are two methods. In the first method you're picking out/solving the values for the time value of money calculation.


  • N, the number of years in their time horizon
  • PV, the present value input is the sum of their current investable assets. One thing to note here when calculating the required return any cash reserves or any things that are specifically carved out of investable assets should not be included in the present value.
  • PMT, which is the net inflows and outflows. This is one area that gets tricky as you're going to need to make sure it's net of any taxes and then also apply any nominal or real adjustments to that value in year 1 if that is indicated
  • FV, basically you have a terminal value that you input and so this is often. Again, if the objective is to maintain real purchasing power, for example, it's often equal to the present value of the portfolio adjusted for inflation
  • Then you just compute the interest rate or whatever which is your required return.

Solving for required return - Method 1

The second method would be to divide the required return for next year by the current total investible assets (PV). For example:

Calculating return requirement

How the CFA Exam (And Candidates) Makes Return Calculations Harder

So how do they make this harder on exams? They throw in taxes that shows up certainly on netting your inflows and outflows but you could be solving for after tax or before tax returns as well. If you're solving for nominal returns you're probably going to have to fold in expected inflation into the numbers that you're using. You need to be aware that you have to adjust present value by subtracting out things like an immediate cash outflow or adding in an immediate cash inflow that happens at the current time period. A specific example here is a house that is often a large chunk of people's investment or their assets but isn't investable so it shouldn't be included. 

One of the things a lot of candidates do here and it really hurts you on exam day, is not showing their work.

If you just put in a return value like 7.8%, well, if that's wrong you just got zero points. Or if your calculation is thrown off because you netted inflows and outflows incorrectly and you didn't explicitly show the numbers and calculations you're going to lose more points than if you make it obvious to the Grader exactly where you slipped up.

The only way to learn the balance between moving quickly and giving enough detail to get partial credit is, you guessed it, practice.