Question

25. Which of the following statements about Defined Benefit pension pl IL The employer is responsible for the investment choices. Employers who sponsor a defined b e loway be required to provide cash to cover funding shortfalls. All else equal, rising interest rates wil cqua, rising interest rates will increase an employer's stated pension liability for defined benefit plan. may be required to provide cash to the plan to A. I only B. II only C. I and II only D. I and Ill only E. L. II and III 20. Which of the following statements about passive management is NOT true A. The objective of passive management is to replicate the performance of an index. B. Strategies that use ETFs are by definition passive strategies. C. A portfolio manager can implement a passive strategy by buying the securities in the index in the same proportions as the index. D. An argument for passive investing is that many actively-managed funds have difficulty outperforming their benchmark. E Fees associated with passive management are lower than those for actively-managed funds. 27. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz? Portfolio Expected Return 12% Standard Deviation 15% 21% 15% A. Only portfolio J cannot lie on the efficient frontier B. Only portfolio K cannot lie on the efficient frontier C. Only portfolio L cannot lie on the efficient frontier D. Only portfolio M cannot lie on the efficient frontier E. Cannot tell from the information given

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Answer 1

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Solution: 25

When it comes to pension plans, there are two kinds of plans generally followed around the globe which are described as follows:

• Defined benefit plans are the plans where the pension benefit to be received by an employee at the time of retirement is defined in advance and the employer must contribute the required funds to ensure that the pension balance at the time of employee's retirement is equal to the defined amount. For this purpose, the employer ensures that the fund today has enough assets whose market value is at least equal to the present value of defined benefit at the time of retirement. If the market value of pension fund assets fall below the present value of defined benefit, the employer must make additional contribution to the fund
• Defined contribution plans require employers to contribute a specified sum periodically and the employer's liability is restricted to that defined sum

Analysis of statements:-

Statement I: In a defined benefit plan, it is the responsibility of the employers to ensure that employees get defined benefits at time of their retirement, therefore the employers are responsible to make investment choices of the pension fund and ensure that the required target of pension benefits is maintained regularly. Therefore, this statement is correct.

Statement II: As detailed above, a defined benefit plan requires employers to ensure that the pension fund has a minimum balance equal to the present value of defined pension benefits required at the time of retirement. Therefore, if the pension fund balance falls below the said present value of future pension benefits, the employer must make additional contributions to cover the shortfall. Therefore, this statement is correct.

Statement III: When the interest rates go up, the discount rate used to calculate present value of defined pension benefits also goes up which results in reduction in the said present value and thus the required balance in pension fund. Therefore, an increase in interest rates reduces the employers' liability to make contribution to the pension fund, and therefore this statement is not correct.

Based on above analysis, the first two statements are true and therefore, the correct option is Option C.