LOS c: Discuss the criteria for selecting a benchmark bond index and justify the selection of a specific index when given a description of an investor's risk aversion, income needs, and liabilities.

Q1. A commercial bank that borrows and then lends funds is most likely to specify its benchmark:

A)   in terms of its liability structure.

B)   in terms of the duration of its assets.

C)   as a bond index.

Q2. A defined benefit pension plan is most likely to specify its benchmark:

A)   in terms of its liability structure.

B)   as a bond index.

C)   in terms of the Lehman Brothers Aggregate Bond Index.

Q3. Fixed-income investors whose objective is to generate sufficient cash to satisfy their liabilities specify the benchmark:

A)   in terms of its liability structure.

B)   as a bond index.

C)   as either a bond index or in terms of its liability structure.

Q4. Which of the following most accurately describes the relationship between an investor's investment objectives and the benchmark chosen for performance evaluation? An investor with a:

A)   liability as a benchmark has an investment strategy to match the timing and amount of the payments corresponding to the liability.

B)   liability as a benchmark has an investment objective that is to earn a higher return than the cost of borrowing.

C)   bond index as a benchmark has as an investment objective to outperform the bond index.

Q5. What is the investment objective for a pension sponsor who has a defined benefits based liability structure? The main objective is to:

A)   minimize prepayment risk.

B)   match the amount and timing of the liability.

C)   outperform a bond index.

LOS c: Discuss the criteria for selecting a benchmark bond index and justify the selection of a specific index when given a description of an investor's risk aversion, income needs, and liabilities. fficeffice" />

Q1. A commercial bank that borrows and then lends funds is most likely to specify its benchmark:

A)   in terms of its liability structure.

B)   in terms of the duration of its assets.

C)   as a bond index.

Correct answer is A)

A commercial bank defines its benchmark in terms of meeting a specific amount of cash to satisfy the liabilities (deposits) on its books.

Q2. A defined benefit pension plan is most likely to specify its benchmark:

A)   in terms of its liability structure.

B)   as a bond index.

C)   in terms of the Lehman Brothers Aggregate Bond Index.

Correct answer is A)

The pension plan defines its benchmark in terms of meeting a specific amount of cash to satisfy the liabilities (pension benefits) on its books.

Q3. Fixed-income investors whose objective is to generate sufficient cash to satisfy their liabilities specify the benchmark:

A)   in terms of its liability structure.

B)   as a bond index.

C)   as either a bond index or in terms of its liability structure.

Correct answer is A)

Fixed-income investors whose objective is to generate sufficient cash to satisfy the liabilities specify the benchmark in terms of its liability structure.

Q4. Which of the following most accurately describes the relationship between an investor's investment objectives and the benchmark chosen for performance evaluation? An investor with a:

A)   liability as a benchmark has an investment strategy to match the timing and amount of the payments corresponding to the liability.

B)   liability as a benchmark has an investment objective that is to earn a higher return than the cost of borrowing.

C)   bond index as a benchmark has as an investment objective to outperform the bond index.

Correct answer is A)

The purpose of using the liability structure as a benchmark is to ensure meeting the liability payment streams, both in timing and amount.

Q5. What is the investment objective for a pension sponsor who has a defined benefits based liability structure? The main objective is to:

A)   minimize prepayment risk.

B)   match the amount and timing of the liability.

C)   outperform a bond index.

Correct answer is B)

Although the other answers are worthwhile activities in pension fund management, matching the liability structure should be the primary objective for the pension sponsor.