Reading 28:Managing Institutional Investor Portfolios- LO

大学

Q7. Helen Smith, CFA, has been assigned the portfolio management responsibilities for her firm’s first institutional investor, Branch Industries Defined Benefit Pension Plan (hereafter referred to as the “Plan”). To date, Smith’s firm has managed money only for high net worth individuals. In addition to her portfolio management duties, Smith has been delegated the task of formulating the investment policy statement (IPS) for the Plan.

Branch Industries manufactures tiny transformers and circuitry used in small electrical appliances, and components for cars and trucks. Silver is a small, but critical, input to the production process, and Branch uses a reliable supplier. Branch’s sales have grown steadily for the past three years despite a rather tepid economic recovery fostered by modest tax cuts and aggressive expansion of the money supply. It appears likely that Federal Reserve policy will remain accommodative, with continued low interest rates. Therefore Branch’s five-year sales forecast is very optimistic. Branch’s profit margins are projected to be in line with its competitors, but the firm is carrying significantly more debt in its capital structure than comparable companies.

Smith has determined the following about the Plan:

The average employee age is 45.5 years, and the active-to-retired participant ratio is high.
The Plan should be considered ongoing, and it has a moderate surplus.
Employees are eligible for retirement at age 62. There are no provisions for lump-sum distributions or early retirement.
The discount rate for the projected benefit obligation (PBO) is 10%.
The expected return on plan assets is 10 percent.

Smith decides she needs to review the terminology, accounting, and other factors affecting the Plan’s funding status. Below is her brief synopsis of relevant terms:

Exhibit A: Pension Terminology

	Definition
PBO	Present value of future benefits earned to date. Assumes plan termination.
ABO	Present value of projected future benefits. Assumes ongoing plan.
Net Pension Cost	Income statement expense to be recognized for a specific year.
Funded (Surplus) Status	Market value of plan assets less the present value of future liabilities.

Smith recalls that the Pension Committee wishes to minimize the volatility of future contributions. They also expressed concern that the discount rate and expected return on plan assets might need modification. She decides to explore these issues further before finishing the IPS or developing an asset allocation recommendation for the portfolio.

Which of the following best explains two constraints that differ between individuals and pension funds and the way they differ?

A) Liquidity and time horizon considerations: pensions always have a greater need for liquidity than individual investors; pensions have infinite lives whereas individuals do not.

B) Legal and time horizon considerations: pensions must follow the Employee Retirement Income Security Act (ERISA) whereas individuals can usually invest as they please; pensions have finite lives whereas individuals do not.

C) Legal and tax considerations: pensions must follow the Employee Retirement Income Security Act (ERISA) whereas individuals can usually invest as they please; pensions are tax-exempt investors whereas individuals pay taxes.

Q8. Regarding the pension terminology in Exhibit A, the definition of:

A) ABO is incorrect; PBO is incorrect; funded status is correct.

B) ABO is correct; PBO is correct; funded status is incorrect.

C) ABO is incorrect; PBO is correct; funded status is correct.

Q9. Future pension contributions required will be directly affected by:

A) the expected return on existing plan assets and pension default expectations.

B) the expected return on existing plan assets and and pension expense requirements.

C) prior expected return estimates and pension expense requirements.

Q10. Considering the characteristics of Branch Industries and the Plan, which of the following statements best describes the ability of the pension plan to take risk?

A) Below average ability to take risk.

B) Above-average ability to take risk.

C) Average ability to take risk.

Q11. Which of the following factors should NOT affect a pension plan’s ability and/or willingness to take risk?

A) Workforce characteristics.

B) Portfolio manager's investment style.

C) Plan surplus.

Q12. To maximize the sponsor’s ability to make pension contributions and meet the Pension Committee’s desire to manage contribution volatility, Smith should give the most consideration to the correlation between the sponsor’s:

A) operating profitability and Plan asset returns.

B) operating profitability and Plan termination potential.

C) net income and the Plan’s ABO.

Q13. The liquidity requirement of a pension plan is directly related to and increased by a:

A) high proportion of active lives.

B) high proportion of retired lives.

C) low proportion of retired lives.

Q14. The discount rate used to determine the present value of pension liabilities is the fund’s:

A) required return.

B) contribution return.

C) desired return.

Q15. The funded status/surplus of a defined benefit plan impacts the risk tolerance of investment activities and is best described as:

A) larger pension surpluses indicate lower risk tolerance.

B) larger pension surpluses indicate higher risk tolerance.

C) there is no relationship between surplus in risk tolerance in a defined benefit plan.

Q16. Which of the following defined benefit pension plans has the greatest ability to accept risk?

Plan	Age of workforce	Ratio of active to retired participants	Sponsor’s debt ratio	Sponsor’s profitability
A	young	high	high	low
B	young	high	low	high
C	older	high	low	high