LOS a: Compare and contrast funding shortfall and asset/liability mismatch as sources of risk faced by pension plan sponsors.

Q1. Which of the following statements regarding sources of risk to the firm is most accurate?

A)   Both asset liability mismatches and funding shortfalls are equal sources of risk for firms.

B)   A funding shortfall is considered to be a bigger source of risk to the firm than an asset liability mismatch.

C)   An asset liability mismatch is considered to be a bigger source of risk to the firm than a funding shortfall.

Q2. Which of the following statements is least accurate regarding the problems associated with an asset/liability mismatch and funding shortfall?

A)   Asset/liability mismatch is a bigger problem than funding shortfall because the risk due to the pension assets being invested in equities does not appear on the balance sheet.

B)   Funding shortfall is a bigger problem than an asset/liability mismatch because most firm's pension plans are underfunded.

C)   The asset/liability mismatch is a bigger problem because the size of many firm’s pension assets is larger than the overall market capitalization of the firm.

Q3. Which of the following statements regarding a funding shortfall is most accurate? A funding shortfall is when the:

A)   present value of pension assets is less than the present value of pension liabilities.

B)   market value of pension assets is less than the market value of pension liabilities.

C)   pension assets on the balance sheet are less than the pension liabilities on the balance sheet.

LOS a: Compare and contrast funding shortfall and asset/liability mismatch as sources of risk faced by pension plan sponsors. fficeffice" />

Q1. Which of the following statements regarding sources of risk to the firm is most accurate?

A)   Both asset liability mismatches and funding shortfalls are equal sources of risk for firms.

B)   A funding shortfall is considered to be a bigger source of risk to the firm than an asset liability mismatch.

C)   An asset liability mismatch is considered to be a bigger source of risk to the firm than a funding shortfall.

Correct answer is C)

A funding shortfall is when the market value of pension assets is less than the market value of pension liabilities. Although this is a concern to sponsors of pension plans a bigger problem is thought to occur due to the asset liability mismatch which is when the pension assets are invested in equities while the pension liabilities have fixed income debt like characteristics. Asset liability mismatch is a bigger risk for several reasons: 1) the balance sheet does not reflect the asset allocation of the pension assets whereas the balance sheet would indicate whether or not the pension plan was underfunded, 2) if the equity markets decrease in value while interest rates decrease the pension assets will also decrease while the pension liabilities will increase in value, 3) it’s not uncommon for a company’s pension assets to be larger in value than the overall market value of equity of the firm and if those assets are invested in equities this will contribute a significant amount of risk to the firm.

Q2. Which of the following statements is least accurate regarding the problems associated with an asset/liability mismatch and funding shortfall?

A)   Asset/liability mismatch is a bigger problem than funding shortfall because the risk due to the pension assets being invested in equities does not appear on the balance sheet.

B)   Funding shortfall is a bigger problem than an asset/liability mismatch because most firm's pension plans are underfunded.

C)   The asset/liability mismatch is a bigger problem because the size of many firm’s pension assets is larger than the overall market capitalization of the firm.

Correct answer is B)         

Asset/liability mismatch is thought to be a bigger problem because of the risk associated with the pension assets being invested in equities; this risk does not show up on the balance sheet. Also there are a significant number of firms whose pension assets are larger than the overall market capitalization of the firm in which case the pension assets add a significant amount of risk to the firm. Most firms are eliminating their defined benefit plans in favor of defined contribution plans.

Q3. Which of the following statements regarding a funding shortfall is most accurate? A funding shortfall is when the:

A)   present value of pension assets is less than the present value of pension liabilities.

B)   market value of pension assets is less than the market value of pension liabilities.

C)   pension assets on the balance sheet are less than the pension liabilities on the balance sheet.

Correct answer is B)

Funding shortfall means the market value of pension assets is less than the market value of pension liabilities.