Reading 25 Book 4 curriculum EOC # 27 - contingent claim ris only, concerned, continue, provided

prashantsahni

Hi All,
Question 27 on page 155 asks for the risks that the manager should be concerned about.
The manager’s immunization approach involves only non-callable bonds.  Yet the manager is concerned about contingent claim risk according to the solution provided in the curriculum.
I am not clear as to why the manager should continue to worry about contingent claim risk if he is only holding non-callable bonds.
Your response is much appreciated.
PS

onelife1

janakisri wrote:
esandun: even though the pension fund is fully funded today , the obligations of the fund still lay a claim on the assets of the corporation . This is modeled with put and call options on the various asset components of the corporation .  For example future funding for the pension is hugely contingent on the continued strength of the fund sponsor as well as the leverage  in the  sponsor balance sheet ( i.e. the debt they acquire ). Any model that tries to derive a discount rate for the pension liabilities definitely makes path dependent assumptions for the variables that drive the sponsor’s financial health
Just because currently the fund is fully funded does not mean that they are free to declare independence from the sponsoring firm for future unmet obligations . Actuarial numbers for liabilities have built in assumptions too which can be modeled with probabilities .options probably are the best market model representation of risky assets and risky liabilities . All options come loaded with contingent claims.
2010 mock q 34 answer explanation supports my argument.

whew1110

@ Janakisri,
Without knnowing the source of fund (loan, donation etc) , how logical it is to answer a MCQ asuming it was funded with a loan , when diffrent assumptions lead to diffrent answers.
Anyway thaks for you time and effort. This is my final comment on this!

prashantsahni

@ Janakisri,
Without knnowing the source of fund (loan, donation etc) , how logical it is to answer a MCQ asuming it was funded with a loan , when diffrent assumptions lead to diffrent answers.
Anyway thaks for you time and effort. This is my final comment on this!

MonkeyBusiness

OK I assumed the hospital was funded by the pension fund , but they have not made the connection .
However the hospital’s projects could be funded with loans:
” local hospital, which is currently fully funded utilizing a standard immunization approach with non- callable bonds” . Doesn’t mean that the bonds are also not putable by the lenders to the hospital.
If the loans are put back to the hospital by lenders when rates rise , that would be a contingent claims risk.

Nishant1

@ Janakisri
I have two point for you
1. This question is not about a pension fund. But about a hospital project  which is fully funded. Not like pension funds (DBs) there no indication of possible future liabilities beyond immunization (thhis is a on -off situation).
2. As I have stated above post, the question clearly say only non-callable bonds are there.
Thanks for the reply, however your reply is out of focus, IMHO.

maratikus

esandun: even though the pension fund is fully funded today , the obligations of the fund still lay a claim on the assets of the corporation . This is modeled with put and call options on the various asset components of the corporation .  For example future funding for the pension is hugely contingent on the continued strength of the fund sponsor as well as the leverage  in the  sponsor balance sheet ( i.e. the debt they acquire ). Any model that tries to derive a discount rate for the pension liabilities definitely makes path dependent assumptions for the variables that drive the sponsor’s financial health
Just because currently the fund is fully funded does not mean that they are free to declare independence from the sponsoring firm for future unmet obligations . Actuarial numbers for liabilities have built in assumptions too which can be modeled with probabilities .options probably are the best market model representation of risky assets and risky liabilities . All options come loaded with contingent claims.

scruge

Any immunized portfolio (except with treasuries) face the credit risk. That is not the focus here.
CFAI text Vol 4, p.38 says “When a security has a contingent claim provision, explicit or implicit, ……”
So it is not default risk.

pogo

I have the same doubt, the cfa answer may be just a general answer.
One more question: which are eligible assets for immunization? Callable bonds are usually high yield bonds, and could default?

studyn

Hi,
Seems some are trying to defend CFAI.
Lets summarize facts in the question.
# The project is fully funded
# ALL are NON-Callable bonds, no other bonds are involved
# Even these bonds are putable, the decision to excercise put option is on portfolio manager’s hand. So it is not a RISK
If anyone say  contingent risk exists here, please show at least ONE CONTINGENT even that can happen to bonds so that ability to meet liability is at a risk?