Directions: Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both for this homework assignment.
Which of the following statements about pension plans if any, is incorrect?
- Under a defined benefit plan, the employer agrees to give retirees a specifically defined benefit, such as $500 per month or 50 percent of the employee’s final salary.
- A portable pension plan is one that an employee can carry from one employer to another.
- An employer’s obligation is satisfied under a defined contribution plan when it makes the required contributions to the plan. The risk of inadequate investment returns is borne by the employee.
- If assets exceed the present value of benefits, the pension plan is fully funded.
- A defined contribution plan is, in effect, a savings plan that is funded by employers, although many plans also permit additional contributions by employees.
Which of the following statements about defined contribution plans is incorrect?
- In general, employees can choose the investment vehicle under a defined contribution plan. Thus, highly risk-averse employees can choose low-risk investments, while more risk-tolerant employees can choose high-risk investments.
- In a defined contribution plan, the employer must make larger-than-average contributions to the pension plan when investment returns have been below expectations.
- Defined benefit plans are used more often by large corporations than by small companies.
- The PBGC insures a portion of pension benefits.
- A defined contribution plan places the risk of poor pension portfolio performance on the employee.
Which of the following statements about pension plan portfolio performance is incorrect?
- Alpha analysis, which relies on the Capital Asset Pricing Model, considers the risk of the portfolio when measuring performance.
- Peer comparison examines the relative performance of portfolio managers with similar investment objectives.
- A portfolio annual return of 12 percent from one investment advisor is not necessarily better than a return of 10 percent from another advisor.
- In managing the retiree portfolio, fund managers often use immunization techniques such as alpha analysis to eliminate, or at least significantly reduce, the risk associated with changing interest rates.
- Pension fund sponsors must evaluate the performance of their portfolio managers periodically as a basis for future asset allocations.
Ms. Lloyd, who is 25 and expects to retire at age 60, has just been hired by the Chambers Corporation. Ms. Lloyd’s current salary is $30,000 per year, but her wages are expected to
increase by 5 percent annually over the next 35 years. Chambers has a defined benefit pension plan in which workers receive 2 percent of their final year’s wages for each year of employment.
Assume a world of certainty. Further, assume that all payments occur at year-end. What is Ms.
Lloyd’s expected annual retirement benefit, rounded to the nearest thousands of dollars?
Kumar Consulting operates several stock investment portfolios that are used by firms for investment of pension plan assets. Last year, one portfolio had a realized return of 12.6 percent and a beta coefficient of 1.15. The average T-bond rate was 7 percent and the realized rate of return on the S&P 500 was 12 percent. What was the portfolio’s alpha?