DBO and pension exp, risk free rate

CFA Level II
#1

What effect does the risk free rate have on these? my assumption, and it could be wrong, is that an increase in the risk free rate would mean a small increase in the overall discount rate, which would then translate to a small increase in both the DBO and the pension expense… please correct me if i am wrong, thanks

#2

I’m assuming DBO -> Defined Benefit Plan Obligation, which consists of PBO, ABO & VBO. In all 3 cases, an INCREASE in the Discount Rate DECREASES all 3 simply because of discounting.

#3

I actually did mean to write decrease… I just finished explaining this to someone else… I hope I don’t have these kinds of lapses on the exam. Discount rate goes up, pension expense and DBO go down Discount rate drops, pension expense and DBO go up

#4

but the risk free rate… is there some twist to it, that’s what I’m wondering.

#5

magicskyfairy Wrote: ------------------------------------------------------- > but the risk free rate… is there some twist to > it, that’s what I’m wondering. I would think Rf rate is used for the rate of return and therefore DBO would be unchanged while Pension Expense would decrease

#6

First we agree an INCREASE in Discount Rates decreases PBO/ABO/VBO, correct? So the question is what about the RISK-FREE rate? While the risk-free rate isn’t explicitly used in the calculations, you have to assume that they are discounting their Pension Obligations by some Rate of REQUIRED Return and any required return should be a risk free + some premium.

#7

^ yes, agree with this line of reasoning completely. However, this is the CFA we’re talking about, and they may have some twist on this which is why I’m asking.