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CAIA > CAIA - 04 - Pension Fund Portfolio Management > Flashcards

CAIA - 04 - Pension Fund Portfolio Management Flashcards

1
Q

What are the advantages of a pension plan?

  1. Employee ___
  2. Reduced ___ ___
  3. ___ - ___
  4. ___ of ___
A

What are the advantages of a pension plan?

  1. Employee retention
  2. Reduced personal savings
  3. Tax-deferred
  4. Economies of scale
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2
Q

There are 3 types of pension plans:

  1. ___ ___
  2. Governmental ___ ___
  3. ___ ___
A

There are 3 types of pension plans:

  1. Defined Benefit
  2. Governmental Social Security
  3. Defined Contribution
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3
Q

A ___ ___ plan is similar to a traditional DB plan in that assets remain in a single investment pool, but shares the characteristics of a DC plan in that the benefits are maintained in individual record-keeping accounts that show the accrued benefit and facilitate portability.

A

A cash balance plan is similar to a traditional DB plan in that assets remain in a single investment pool, but shares the characteristics of a DC plan in that the benefits are maintained in individual record-keeping accounts that show the accrued benefit and facilitate portability.

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4
Q

A DB plan’s risk can be measured three ways:

  1. Asset-___
  2. Asset-___
  3. ___ asset-___
A

A DB plan’s risk can be measured three ways:

  1. Asset-focused
  2. Asset-liability
  3. Integrated asset-liability
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5
Q

Under ___-___ risk management, the risk of a DB plan is measured in terms of the volatility of its assets.

A

Under asset-focused risk management, the risk of a DB plan is measured in terms of the volatility of its assets.

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6
Q

Under ___-___risk management, the DB Plan’s risk is measured in terms of the volatility of its surplus.

A

Under asset-liability risk management, the DB Plan’s risk is measured in terms of the volatility of its surplus.

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7
Q

In an ____ ____ -____ risk management approach, the Plan’s funding status and the sponsor’s operations are integrated and it is preferred that the surplus be negatively correlated with the sponsor’s profitability.

A

In an integrated asset-liability risk management approach, the Plan’s funding status and the sponsor’s operations are integrated and it is preferred that the surplus be negatively correlated with the sponsor’s profitability.

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8
Q

There are 4 key factors that affect the value of a plan’s liabilities:

  1. ___ ___
  2. ___
  3. ___ ___
  4. ___ ___
A

There are 4 key factors that affect the value of a plan’s liabilities:

1. Interest rates

2. Inflation

3. Retirement cycle

4. Mortality rate

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9
Q

___ ___ are the most important factor that affect liability values

A

Interest rates are the most important factor that affect liability values

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10
Q

The value of liabilities are (positively/negatively) correlated with inflation.

A

The value of liabilities are positively correlated with inflation.

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11
Q

The value of liabilities is ___ correlated with the number of future retirees.

A

The value of liabilities is positively correlated with the number of future retirees.

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12
Q

The value of liabilities is (positively/negatively) correlated with mortality rate.

A

The value of liabilities is negatively correlated with mortality rate.

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13
Q

5 factors impact the risk tolerance of plan sponsors:

  1. ___ status
  2. Fund ___
  3. Expected future ___ relative to employer ___ ___
  4. Employer’s ___ ___
  5. Employees’ ___
A

5 factors impact the risk tolerance of plan sponsors:

  1. Funding status
  2. Fund size
  3. Expected future contributions relative to employer cash flow
  4. Employer’s financial position
  5. Employees’ characteristics
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14
Q

Plan sponsors with underfunded DB plans with large deficits tend to have (more/less) risk tolerance

A

Plan sponsors with underfunded DB plans with large deficits tend to have less risk tolerance

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15
Q

Sponsors with large plan liablities relative to the size of their assets have (high/low) risk tolerance

A

Sponsors with large plan liablities relative to the size of their assets have high risk tolerance

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16
Q

Sponsors with large expected future free cash flows compared to projections needed to cover obligations have (higher/lower) risk tolerance.

A

Sponsors with large expected future free cash flows compared to projections needed to cover obligations have higher risk tolerance.

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17
Q

Sponsors with younger employees tend to have a (higher/lower) risk tolerance

A

Sponsors with younger employees tend to have a higher risk tolerance

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18
Q

Some DB plans use a simple strategic asset allocation approach that divides the portfolio into two buckets: a ___ bucket and a ___ bucket.

A

Some DB plans use a simple strategic asset allocation approach that divides the portfolio into two buckets: a hedging bucket and a growth bucket.

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19
Q

The ___ bucket is constructed to simulate the liabilities growth and aims to reduce the volatility of the fund’s surplus

A

The hedging bucket is constructed to simulate the liabilities growth and aims to reduce the volatility of the fund’s surplus

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20
Q

In the asset-liablity framework, the hedging bucket can be constructed in 3 ways:

  1. ___ matching approach
  2. ___ ___ matching approach
  3. ___ approach
A

In the asset-liablity framework, the hedging bucket can be constructed in 3 ways:

  1. Duration matching approach
  2. Cash flow matching approach
  3. Overlay approach
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21
Q

In the ___ matching approach, the hedging bucket is constructed so that its duration matches the liabilities. It must be monitored and ___ since changes in the ___ ___ and ___ ___ affect duration.

A

In the duration matching approach, the hedging bucket is constructed so that its duration matches the liabilities. It must be monitored and rebalanced since changes in the yield curve and credit spreads affect duration.

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22
Q

In the ___ ___ matching approach, the hedging bucket is constructed such that its expected future cash inflows match its expected liability cash outflows. This involves constructing a portfolio of ___ ___ bonds that mature on the dates the future payments are needed in amounts equal to those payments.

A

In the cash flow matching approach, the hedging bucket is constructed such that its expected future cash inflows match its expected liability cash outflows. This involves constructing a portfolio of zero coupon bonds that mature on the dates the future payments are needed in amounts equal to those payments.

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23
Q

In the ___ approach, the hedging bucket is constructed using derivatives. The use of derivatives may result in ___ positions, which increases the ___ of the portfolio.

A

In the overlay approach, the hedging bucket is constructed using derivatives. The use of derivatives may result in leveraged positions, which increases the risk of the portfolio.

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24
Q

The ___ bucket is composed of investments that are expected to outperform the plan’s liabilities, thus reducing the sponsor’s future contributions to the fund. The allocation size depends on the sponsor’s propensity to assume ___ risk.

A

The growth bucket is composed of investments that are expected to outperform the plan’s liabilities, thus reducing the sponsor’s future contributions to the fund. The allocation size depends on the sponsor’s propensity to assume surplus risk.

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25
Q

An employee’s benefit relative to final salary is referred to as the employee’s ___ ___-___ratio.

A

An employee’s benefit relative to final salary is referred to as the employee’s retirement income-replacement ratio.

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26
Q

A key characteristic of DB plans is that they (are/are not) portable.

A

A key characteristic of DB plans is that they are not portable.

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27
Q

Pension liabilities can be categorized as two types:

  1. ___ benefit obligation
  2. ___benefit obligation
A

Pension liabilities can be categorized as two types:

  1. Accumulated benefit obligation
  2. Projected benefit obligation
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28
Q

What is the equation for calculating change in projected benefit obligations (PBOs) (aka Liabilities)

A
29
Q

A pension plan’s ___ ___ is the amount of its assets compared to its PBO or ABO

A

A pension plan’s funded status is the amount of its assets compared to its PBO or ABO

30
Q

Overfunded plans have a ___ ___

A

Overfunded plans have a pension surplus

31
Q

Plans should aim to be about ___% funded.

A

Plans should aim to be about 100% funded.

32
Q

Overfunded plans may attract employees who want to earn ___ ___ or corporate merger partners who want to ___ the pension fund and keep the ___ ___ .

A

Overfunded plans may attract employees who want to earn larger benefits or corporate merger partners who want to dismantle the pension fund and keep the surplus value.

33
Q

Underfunded plans may require larger ___ ___and attract ___ ___.

A

Underfunded plans may require larger employer contributions and attract regulatory scrutiny.

34
Q

A plan’s ___ ___ is its economic exposure to the spread between its assets and liabilities.

A

A plan’s surplus risk is its economic exposure to the spread between its assets and liabilities.

35
Q

Surplus risk may be measured as the ___ of the difference between ___values and the ___ ___value.

A

Surplus risk may be measured as the volatility of the difference between asset values and the liabilities present value.

36
Q

Surplus risk is higher when assets and liabilities are ___ correlated.

A

Surplus risk is higher when assets and liabilities are negatively correlated.

37
Q

Balance sheets of companies (do/do not) reflect their surplus risk.

A

Balance sheets of companies do reflect their surplus risk.

38
Q

A number of factors have contributed to decreased use of DB pension plans.

  1. ___
  2. ___changes
  3. ___risk
  4. Lack of ___
A

A number of factors have contributed to decreased use of DB pension plans.

  1. Unaffordability
  2. Regulatory changes
  3. Equity risk
  4. Lack of portability
39
Q

The U.S. Pension Protection Act of 2006 requires that corporate employers disclose the plan’s ___ ___to plan participants and requires employer contributions to match the funding status. Underfunded plans must increase the contributions such that the plan is fully funded within ___years.

A

The U.S. Pension Protection Act of 2006 requires that corporate employers disclose the plan’s funded status to plan participants and requires employer contributions to match the funding status. Underfunded plans must increase the contributions such that the plan is fully funded within seven years.

40
Q

According to Merton (2006), companies with large pension deficits may have ___ multiples of earnings and book value, exhibit higher stock price ___, and have higher ___.

A

According to Merton (2006), companies with large pension deficits may have lower multiples of earnings and book value, exhibit higher stock price volatility, and have higher betas.

41
Q

In ___ plans, employees scheduled to receive DB pension plans do not accrue additional years of service in the plan.

A

In frozen plans, employees scheduled to receive DB pension plans do not accrue additional years of service in the plan.

42
Q

Employers that choose to stop offering DB plans have a number of options: they can establish a ___-___structure in which newly hired employees are offered a ___ ___ pension plan, or they can ___or ___the plan.

A

Employers that choose to stop offering DB plans have a number of options: they can establish a two-tier structure in which newly hired employees are offered a less generous pension plan, or they can freeze or terminate the plan.

43
Q

A ___ plan is no longer operated by the employer, so the employer no longer controls the assets. When the plan is ___the assets are either paid to employees in ___ ___or used to buy ___to cover future retiree benefits.

A

A terminated plan is no longer operated by the employer, so the employer no longer controls the assets. When the plan is terminated the assets are either paid to employees in lump sums or used to buy annuities to cover future retiree benefits.

44
Q

Pension plan sponsors have two conflicting goals when designing the asset allocation:

  1. To earn a ___ ___on pension assets
  2. To minimize the plan’s level of ___ ___
A

Pension plan sponsors have two conflicting goals when designing the asset allocation:

  1. To earn a high return on pension assets
  2. To minimize the plan’s level of surplus risk
45
Q

___-___ ___reduces surplus risk by constructing a portfolio of assets with returns that are highly correlated with the change in the plan’s liabilities.

A

Liability-driven investing reduces surplus risk by constructing a portfolio of assets with returns that are highly correlated with the change in the plan’s liabilities.

46
Q

There are different ways to immunize a pension fund’s liabilities.

  1. Use a ___ bond portfolio with a ___that matches that of the pension’s liabilities.
  2. Use ___ ___, such as ___that receive long-duration bond returns or ___that increase in value as interest rates ___.
A

There are different ways to immunize a pension fund’s liabilities.

  1. Use a corporate bond portfolio with a duration that matches that of the pension’s liabilities.
  2. Use derivative overlays, such as swaps that receive long-duration bond returns or swaptions that increase in value as interest rates decrease.
47
Q

Plans offering benefits with large COLA adjustments need large allocations to ___-___ ___in order to reduce surplus risk

A

Plans offering benefits with large COLA adjustments need large allocations to inflation-protected bonds in order to reduce surplus risk

48
Q

Instead of using low return-yielding inflation-protected bonds, portfolios can be protected against inflation using ___ ___.

A

Instead of using low return-yielding inflation-protected bonds, portfolios can be protected against inflation using real assets.

49
Q

In contrast to DB plans that do not cap benefits, social security plans cap earnings. This results in a ___ ___ , in which retirees with lower career-average incomes receive relatively higher benefits as a percentage of salary than higher-income retirees.

A

In contrast to DB plans that do not cap benefits, social security plans cap earnings. This results in a progressive system, in which retirees with lower career-average incomes receive relatively higher benefits as a percentage of salary than higher-income retirees.

50
Q

A ___ ___plan is a retirement plan in which employers make a specific contribution on behalf of each covered employee and employees also contribute to the plan.

A

A defined contribution plan is a retirement plan in which employers make a specific contribution on behalf of each covered employee and employees also contribute to the plan.

51
Q

DC Plans differ from DB plan in a number of ways:

  1. They are ___
  2. ___risk is borne by the employees
  3. ___ ___are made by the employees
A

DC Plans differ from DB plan in a number of ways:

  1. They are portable
  2. Longevity risk is borne by the employees
  3. Investment decisions are made by the employees
52
Q

Some employees are offered a ___ ___ by the employer, enabling them to invest in a broader range of investment options. However, they typically only benefit financially ___employees.

A

Some employees are offered a brokerage window by the employer, enabling them to invest in a broader range of investment options. However, they typically only benefit financially sophisticated employees.

53
Q

When participants in a DC plan do not rebalance, it results in a ___ asset allocation.

A

When participants in a DC plan do not rebalance, it results in a drifting asset allocation.

54
Q

There are 2 key phases related to retirement:

  1. ___ phase
  2. ___phase
A

There are 2 key phases related to retirement:

  1. Accumulation phase
  2. Decumulation phase
55
Q

DC Plan participants are exposed to 3 chief risks:

  1. ___ risk
  2. ___risk
  3. ___risk
A

DC Plan participants are exposed to 3 chief risks:

  1. Longevity risk
  2. Market risk
  3. Inflation risk
56
Q

What is the equation for estimating longevity risk (economic life in years)

A
57
Q

There are two broad types of annuities:

  1. ___ annuity
  2. ___annuity
A

There are two broad types of annuities:

  1. Immediate annuity
  2. Deferred annuity
58
Q

In an ___ annuity, the investor makes a lump-sum payment to an insurance company in exchange for a series of guaranteed cash flows scheduled to start within the first year.

A

In an immediate annuity, the investor makes a lump-sum payment to an insurance company in exchange for a series of guaranteed cash flows scheduled to start within the first year.

59
Q

With a ___ annuity, an investor makes a lump-sum payment to an insurance company in exchange for a series of guaranteed cash flows scheduled to start at a future date.

A

With a deferred annuity, an investor makes a lump-sum payment to an insurance company in exchange for a series of guaranteed cash flows scheduled to start at a future date.

60
Q

Deferred annuities are sometimes referred to as ___ ___.

A

Deferred annuities are sometimes referred to as longevity insurance.

61
Q

An ___ annuity is one where the payment does not grow over time.

A

An ordinary annuity is one where the payment does not grow over time.

62
Q

A ___ annuity is one where payments will grow over time.

A

A growth annuity is one where payments will grow over time.

63
Q

What’s the equation for present value of a growth annuity?

A
64
Q

What is the equation for the present value of an ordinary annuity?

A
65
Q

The cost of a growth annuity is (more/less) than that of a fixed annuity.

A

The cost of a growth annuity is more than that of a fixed annuity.

66
Q

The cost of a deferred annuity is (more/less) than that of an immediate annuity.

A

The cost of a deferred annuity is less than that of an immediate annuity.

67
Q

When interest rates decrease, the cost of an annuity (increases/decreases).

A

When interest rates decrease, the cost of an annuity increases.

68
Q

When the payment period increases, the cost of an annuity (increases/decreases).

A

When the payment period increases, the cost of an annuity increases.

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