This is regarding the Schweser Practise Exam Vol 1 Exam 3 AM - Smith Hospital Corporation, Question 8B.
Even though the text/case clearly mentions that no cost of living adjustments would be provided for, then why does the solution allocate liability exposure for “Deferred retirees” and “Active accrued” as 100% real rate bonds? Wouldn’t nominal bonds do the trick just fine?
As an aside, anyone else who took this test feel it was quite lengthy / hard? I got rogered!
bump
real rate bonds do not have an inflation return component
Nominal bonds have a real + inflation return component.
For this quesiton you have no inflation (no COLA), so no need for that extra return.
^ Real rate bonds are adjusted to reflect inflation, They’re real.
I know you’re thinking nominal=real + inflation
with nominal you get a fixed rate that stays the same regardless whether inflation increases or decreases.
Real rate bonds adjust the principal and coupons to counter inflation impact
Hi meshed,
I just took that exam. I did badly on that question as well but because of the correlations (apparenty if future wage inflation has a 60% correlation with CPI then it is matched with 60% real bonds and 40% nominal). Regarding the cost of living adjustments, the question starts:
“Based on Weekly’s proposal to modify the existing defined benefit plan to provide cost of living adjustments”
If you look in the text, it says:
“She proposes that all future retirees will receive cost of living adjustents in their payouts. This will affect all payouts other than payouts for current retirees”
Hence, deferred and active accrued need real rate bonds.
Regarding the exam, I found the Q2 and Q3 horrible. Q2 especially as it made you go back to the text in Q1 and was really not clear. I’m not sure if there’s a good strategy for those questions. The attribution question was great though, 24 points for some basic cals that can be done in 5 minutes.
Ah you’re right. I keep switching this concept up in my mind, to me it’s backwards.
thank you everyone for helping out!