sorry you guys have to read the whole thing…for just one question…but I really need some thoughts on this… 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. 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) Average ability to take risk. C) Above-average ability to take risk.
C?
Surplus is moderate, so there is a surplus. Average age is about 20 years below retirement age, so there is room for risk taking. So I say above average too, even if I am expecting an Average solution…
If I look at this question objectively I’m going with “C” because there is a surplus, a high ratio of active to retired lives, and an average of 16.5 years to retirement. If I look at this question knowing that you think it sucks I’m going “A” and I’m guessing their explanation has to do with having a minimal surplus, a lot of debt, and only having one silver supplier. Talk about rampant speculation on my part! My final answer for the purposes of this thread is A, but on the exam I would choose C.
mumu only posts traps. I just thought I would be the first to walk in.
I am not picking C. Looking at company itself: read the information more closly, it says the company has significant more debt in this capital structure than its competitor. Therefore that ability below-average. Look at the plan itself: The fact that workfore is “young”, higer active-to-retired participant ratio, and surplus give above-average ability. Given the positive and negative, it is a wash. So, if on the exam, I am going to pick B—Average
A) Discount rate applied to liabilities is unrealistically high or some jazz like that given the forecasted low rates. Applying a lower discount would murder the surplus Just throwing it out there.
These suck. since profits correlated w/ economy and highly leveraged and the return objective is to min vol of future contributions I am going to go A below average. Time Frame is long = above average ability. Active to retired is high = above ave mod surplus = ave business highly correlated w/ economy/mkt = below ave sig more debt/high leverage = mag impact of profit/loss = below ave PBO of 10% is kinda high so Liab is potentially too low so mod surplus is too high ? = below ave objective to min vol of future contr = protect mod surplus = below ave if high equity exposure then portf declines and contributions would be required at the same time profits are down = below ave ability below / ave / above 5 / 1 / 2 that said I think I gave multiple points on the below side for the same thing…
ws Wrote: ------------------------------------------------------- > I am not picking C. > > Looking at company itself: > read the information more closly, it says the > company has significant more debt in this capital > structure than its competitor. Therefore that > ability below-average. If you want to go that far, then you could say that the since the econ conditions are not expected to change the debt would actually be a good thing. They are more levered up and should receive a higher return than their competitors. Sales are supposed to increase and their margins are in line. Not sure how to interpret that. Also (I should know this already) but do we even take the firm into account here? It asks the pension plans ability to take risk. Based on the fundamentals there is no need to make contributions in the near term. > > Look at the plan itself: > The fact that workfore is “young”, higer > active-to-retired participant ratio, and surplus > give above-average ability. > > Given the positive and negative, it is a wash. > > So, if on the exam, I am going to pick B—Average
slouiscar Wrote: ------------------------------------------------------- > mod surplus = ave > A moderate surplus would be considered average? deficit = below average mod surplus = average big surplus = above average Would that be right?
doworkson Wrote: ------------------------------------------------------- > A) Discount rate applied to liabilities is > unrealistically high or some jazz like that given > the forecasted low rates. Applying a lower > discount would murder the surplus > > Just throwing it out there. That’s an excellent point. A low surplus and a high discount rate means that the plan is probably underfunded.
MWVT To your second question, YES. In the material, you need to incorporate the firm’s general financial health and plan’s feature to determine the overall risk ability.
wow…I didn’t even think about half these things…but its good stuff… keep it rollin…I’m going out for a baby’s first birthday party tonight…will post the answer in a couple of hours!! haha…love the torture… adios…
I think I would say B because the surplus is only moderate.
ws Wrote: ------------------------------------------------------- > MWVT > > To your second question, YES. In the material, > you need to incorporate the firm’s general > financial health and plan’s feature to determine > the overall risk ability. Thanks.
Ave. B
A Moderate surplus, but would prefer low valitility of future contributions, so beats the benefit of mod surplus higher debt high discount rate in an expansionary environment
B My rationale: a. Things working for the case of High Ability to take risk include high surplus, high active:retired ration; good plan features b. Things working against ability to take risk: Need to to minimize future volatility and concerns on revising the expected return rates I think within the IPS, you’d need to honor the wishes of the committee and not take as much risk as the ability would allow. SO…I’m going with B: Average ability to take risk
- So what’s the final answer, mumukada? 2) And more importantly, are real exam questions really this tricky (i.e. is this indicative of a real exam question)? From my experience so far with Stalla practice questions, they seem pretty straight forward. This one has way too much info. Can someone who’s already taken level 3 exam before answer my question? Thanks. BTW, my final answer is D. It is written.
Your answer: C was incorrect. The correct answer was B) Average ability to take risk. Overall, the data Smith has gathered so far indicate an average tolerance for risk. The plan surplus indicates that the present value of plan liabilities is more than covered by the present value of plan assets. Pension plans with restrictive plan features, such as no early retirement or lump-sum distribution provisions increases the duration of the liabilities which, in turn, allows for a higher risk tolerance. The workforce is young; a high active to retired lives ratio indicates a large portion of the workforce is still working while only a small portion of beneficiaries is receiving plan benefit payments. All of these factors indicate an above-average ability to take risk. However, if the Pension Committee were to decrease the discount rate, the PBO would rise and the surplus could disappear. Also, a spike in commodity prices (silver required and only one supplier) and/or the cyclicality of the auto industry could adversely affect Branch’s sales and profit margins. Hence, Branch’s ability to make contributions if the economy slumps, could be compromised. In addition, Branch is more heavily leveraged than its competitors. This could also impact its ability to make timely contributions in an economic downturn. These factors imply less ability to take risk, especially in light of the Pension Committee’s expressed desire to control the volatility of contributions. (Study Session 5, LOS 21.c) Some of you did get it right…but I’m not sure they were right for all the right reasons… What bugs me …is the thought process behind this question… 1. They first discuss all the reasons for the plan to have above average tolerance - which is fine - They Mention Plan Surplus, Restricitve plan features = higher duration, Young workforce, High active to retired life ratio 2. Then they go on to “assume” a lot of scenarios to justify a below average tolerance! - IF the pension committee were to decrease discount rate PBO would rise and surplus would disappear - there is no indication that they could reduce discount rate…so we’re supposed to just say that because 10% is relatively high they will reduce it??? - Spike in commodity prices - ok I get this - so they have one supplier - that’s risky - Cyclicality in the Auto industry (even though the vignette mentions “Therefore Branch’s five-year sales forecast is very optimistic” AND "Branch’s sales have grown steadily for the past three years despite a rather tepid economic recovery " - Ability to make contributions IF the economy slumps - nothing in the vignette suggest this could happen!!! - More heavily levered than competitors - ok …agree with this… - Control volatility of contributions - ok…agree with this too… I still think there are more reasons for above average than the below average /average risks listed…plus i would not have made so many “assumptions” …i would’ve just gone with the current info in the vignette am i just being silly?