nannan66

I think this can seem to be confusing because we were taught in level 2 that the risk level of assets are not affected by the capital structure (i.e. the asset beta remains the same no matter how much debt is used in the capital structure).

The point of this exercise is that we can calculate the beta of total assets. First, we find the beta of total assets with pension assets and liabilities included. Because we know the beta of the total assets and the beta of the pension assets, we can then back into the implied beta of the operating assets.

This formula directly relates to the risk budget. Point being that a firm can assume more risk in its core business depending upon the how the pension portfolio is constructed. This would implie more risk in operating assets, but the same overall level of risk for the firm.

This did not click for me at first, but then I had an "ah ha" moment. Just have to step back and think of the big picture here.