MIP Ch 3: Managing Institutional Investor Portfolios

Question 1

Describe institutional investors.

Answer 1

Institutional investors are legal entities that ultimately serve as intermediaries
between individuals and investment markets

Examples include:
Ÿ DB/DC plans
Ÿ Foundations and Endowments
Ÿ Life and Non-Life Insurance Companies
Ÿ Banks

Question 2

State some of the key differences between DB and DC pension plans.

Answer 2

1. A DC plan has no financial liability; a DB plan does
2. DC plan participants bear the investment risk; the plan sponsor bears this risk for
   DB plans
3. The contributions and investment returns legally belong to the DC plan participant
4. DC retirement assets are more portable (subject to vesting and tax penalties)

Question 3

Describe foundations.

Answer 3

Foundations are grant-making institutions funded by gifts and investment income

Foundations are usually funded by a single donor

Question 4

Describe endowments.

Answer 4

Endowments are long-term funds owned by nonprofit institutions like universities
and hospitals

Endowments are usually funded by many people over time

Question 5

State the objectives in managing securities portfolios

Answer 5

1. Manage overall risk of the balance sheet
2. Manage liquidity
3. Produce income
4. Manage credit risk (substantial credit risk is already in the loan portfolio)
5. To meet other needs (e.g. regulatory constraints)

Question 6

How is net interest margin calculated?

Answer 6

Net interest margin equals interest income minus interest expense, divided by
average earning assets

Or, equivalently, net interest margin is the ratio of net interest income to invested
assets

Question 7

How is the leverage-adjusted duration gap calculated?

Answer 7

DA kDL
k
L /
A

Question 8

Describe the impact from interest rate changes for a company with a positive
leverage-adjusted duration gap

Answer 8

If interest rates fall, the company will have a gain

If interest rate rise, the company will have a loss

Question 9

What are the principal investment issues for DC plans?

Answer 9

1. Diversification
   Ÿ ERISA requires at least three options and granting the participant rights to move
   between the options at least quarterly
2. Company stock
   Ÿ Should be limited to ensure diversification

Question 10

Describe cash balance pension plans.

Answer 10

Sponsor bears the investment risk

Looks like a DC plan to the participant (account balance, contribution credit,
earnings credit)

Contribution credit is percentage of pay based on age

Earnings credit tied to long-term interest rates

Usually from converted DB plans; the conversion often hurts older workers with
many years of service

Question 11

Describe Employee Stock Ownership Plan (ESOP) pension plans.

Answer 11

Much of the plan assets are invested in employee stock

The contribution is usually a percentage of the employee pay

Some sell the stock at a discount

Some allow employee contribution, while others prohibit it

A problem occurs if the company fails because the participant may lose their job
and much of their retirement savings at the same time

Question 12

State the four main types of foundations.

Answer 12

1. Independent (funded by individual donor and usually requiring payouts of at least
   5% annually; this is the dominant type of foundation)
2. Company sponsored (usually short-term focus)
3. Operating (income to support specific programs)
4. Community (fund a variety of grants)