I can’t get my head around the CFA’s explanations for these questions.
Question 6:
C is correct. There is no apparent correlation between the sponsor’s business (banking) and the plan investments (fixed-income securities), and Li has not expressed a concern for them in her description of the plan.
The vignette states that “We make variable-rate loans to individuals and small businesses funded primarily by deposits” wouldn’t this create correlation through sensitivity to interest rates?
Additionally, the explanation states
A is incorrect. The defined benefit plan’s design effectively allows for excess contributions through asset forfeitures from terminated employees and has a reduced risk of accumulated benefits growing too large because of the tendency of employees to leave the company after a limited number of years.
Earlier, the vignette states that “Those who do not remain employed long enough to become fully vested forfeit some or all of the benefit. Pure uses these forfeited funds to reduce its future contributions to the plan’s trust”
If the plan is using forfeited benefits to reduce contributions, how does the plan’s design allow for excess contributions? Additionally, based on the explanation, it sounds like the plan’s design would also be a least concern to the sponsor.
Question 7
The portfolio’s assets exceed the present value of the deferred compensation plan’s vested benefits, so the plan currently has a surplus. Contributions are made for the 20% of employees who leave before their benefits have vested, providing a source of excess funding for the plan as the benefits are forfeited.
Again, I interpreted the vignette as stating that there could be no excess funding, because forfeited benefits would reduce sponsor contributions. This would also contradict the plan being in a surplus since interest rates used to discount the liabilities would be low (given the low current yield).
Anyone have any insight or another explanation?
Many thanks!