Schweser p37 in concept checkers states, “Return: Actuarial rate” There’s also a table on p32 that says essentially the same. There is no reference to adding inflation to the RR.
Go to Volume 2 CFAI, page 403…the first sentence of 2.1.2 Return Objectives….”….on an inflation adjusted basis”. If I was told the rate was on an inflation adjusted basis, I would not add inflation however need to account for it unless otherwise told.
Schweser p37 in concept checkers states, “Return: Actuarial rate” There’s also a table on p32 that says essentially the same. There is no reference to adding inflation to the RR.
Sorry, i should state the Schweser Notes i have is of 2010. However, the table on page 32 shown as Figure 5 takes place. The table you are referring to is titled as “Factors AFFECTING Investment Policies of Institutional Investors” - hence, you need to take it (Actuarial Rate) as just one factor affecting the Return Objective value.
Look, Schweser is plain crap. Name an official CFAI citation where inflation is in the RR and we can continue this discussion.
This is your personal opinion calling it as ‘crap” but a fact. Enjoy.
Regarding CFAI citations. Volume 2, page 403, Section 2.1.2 begings with: “A DB pension plan’s BROAD return objectiveis to achieve returns that adequately fund its pension liabilities on an INFLATION-ADJUSTED BASIS…..Therefore, for a fully funded pension plan, the portfolio manager SHOULD determine the return requirement BEGINNING with the discount rate used to calculate the present value of plan liabilities….”
Next, the same volume, Example 7, page 410, read on “Investment Goals and Objectives”.
Next, Volume 3, page 303, the last para begins with: “In either an ALM or AO approach, if pension liabilities are FIXED in NOMINAL terms, inflation is not a concern. Otherwise, the advisor needs to consider HOW MUCH inflation protection the asset allocation is expected to afford.”
Thus, if you are given an inflation rate in the Q, then, it means the concern and you should adjust therefore for it the return requirement.
All your points are good ones, but what’s going through my mind is that you’re mixing up the return requirements with the return objective. I assume we’re talking about the return requirement.
Going back to vol 2, p403, 2.1.1, that paragraph says what we need to know. If pension assets equal the PV of pension liabilities and the rate of return earned on the assets equals the discount rate used to calculate the liability, the pension assets should be exactly sufficient to pay the liabilities as they mature (middle of the paragraph).
But follow on to your comment about “therefore for a fully funded pension plan….return requirment BEGINNING with the discount rate…” We are then placed into the land of return desires and return objectives which are explained throughout the rest of the section. We move away from RR to RO, however. Example 7 on p410 extends this discussion as to RO but doesn’t shed any new light as to RR.
Vol 3, p303 is interesting and I have to look back at this a little later. The whole point of this section is establishing plan objectives, where clearly we have to consider additional factors beyond the actuarial discount rate. Look carefully at example 17 on p305, specifically the top paragraph which references the return requirement (7.5%), which is still just the rate used for actuarial valuation purposes.
I still say that RR = actuarial discount rate if the plan is fully funded. In any event, we’ll eventually find out.
Agree. As i understood from the text, the RR is a specific either numerical or qualitative concept which is a part of a broad RO. It is also said about that somewhere in the text. However, let me ask you about the quantitative value of the RR if a Q provides us with an inflation concern - we cannot just state that our RR is the discount rate, BUT our RO is to earn such a return on plan assets as to compensate for future inflation? WHY? Because in that case you will not be able to run optimization, i.e. to allocate assets of the portfolio according to your IPS.
I think that either specific answer would earn a partial credit only. That is why i answered in two parts: 1) the minimum required rate is 5%, and 2) the return objective is to earn bla…bla…bla.
Studying With
koontab
Read KEY CONCEPTS.
Studying With
Do you mean SS5? I still can’t find discussion on when or when not to add inflation.
Schweser p37 in concept checkers states, “Return: Actuarial rate” There’s also a table on p32 that says essentially the same. There is no reference to adding inflation to the RR.
HM
^ what if you are given a discount rate instead of actuarial rate….?
Go to Volume 2 CFAI, page 403…the first sentence of 2.1.2 Return Objectives….”….on an inflation adjusted basis”. If I was told the rate was on an inflation adjusted basis, I would not add inflation however need to account for it unless otherwise told.
Studying With
Sorry, i should state the Schweser Notes i have is of 2010. However, the table on page 32 shown as Figure 5 takes place. The table you are referring to is titled as “Factors AFFECTING Investment Policies of Institutional Investors” - hence, you need to take it (Actuarial Rate) as just one factor affecting the Return Objective value.
Look, Schweser is plain crap. Name an official CFAI citation where inflation is in the RR and we can continue this discussion.
HM
What was this question worth?
am feeling depressed abt this exam….
______________________________________________________
You must be the square root of two cause i feel irrational around you
http://alphahive.wordpress.com/
Studying With
This is your personal opinion calling it as ‘crap” but a fact. Enjoy.
Regarding CFAI citations. Volume 2, page 403, Section 2.1.2 begings with: “A DB pension plan’s BROAD return objectiveis to achieve returns that adequately fund its pension liabilities on an INFLATION-ADJUSTED BASIS…..Therefore, for a fully funded pension plan, the portfolio manager SHOULD determine the return requirement BEGINNING with the discount rate used to calculate the present value of plan liabilities….”
Next, the same volume, Example 7, page 410, read on “Investment Goals and Objectives”.
Next, Volume 3, page 303, the last para begins with: “In either an ALM or AO approach, if pension liabilities are FIXED in NOMINAL terms, inflation is not a concern. Otherwise, the advisor needs to consider HOW MUCH inflation protection the asset allocation is expected to afford.”
Thus, if you are given an inflation rate in the Q, then, it means the concern and you should adjust therefore for it the return requirement.
All your points are good ones, but what’s going through my mind is that you’re mixing up the return requirements with the return objective. I assume we’re talking about the return requirement.
Going back to vol 2, p403, 2.1.1, that paragraph says what we need to know. If pension assets equal the PV of pension liabilities and the rate of return earned on the assets equals the discount rate used to calculate the liability, the pension assets should be exactly sufficient to pay the liabilities as they mature (middle of the paragraph).
But follow on to your comment about “therefore for a fully funded pension plan….return requirment BEGINNING with the discount rate…” We are then placed into the land of return desires and return objectives which are explained throughout the rest of the section. We move away from RR to RO, however. Example 7 on p410 extends this discussion as to RO but doesn’t shed any new light as to RR.
Vol 3, p303 is interesting and I have to look back at this a little later. The whole point of this section is establishing plan objectives, where clearly we have to consider additional factors beyond the actuarial discount rate. Look carefully at example 17 on p305, specifically the top paragraph which references the return requirement (7.5%), which is still just the rate used for actuarial valuation purposes.
I still say that RR = actuarial discount rate if the plan is fully funded. In any event, we’ll eventually find out.
HM
Studying With
Agree. As i understood from the text, the RR is a specific either numerical or qualitative concept which is a part of a broad RO. It is also said about that somewhere in the text. However, let me ask you about the quantitative value of the RR if a Q provides us with an inflation concern - we cannot just state that our RR is the discount rate, BUT our RO is to earn such a return on plan assets as to compensate for future inflation? WHY? Because in that case you will not be able to run optimization, i.e. to allocate assets of the portfolio according to your IPS.
I think that either specific answer would earn a partial credit only. That is why i answered in two parts: 1) the minimum required rate is 5%, and 2) the return objective is to earn bla…bla…bla.
My knowledge of the subject is limited to what’s in the book. There are others in the actuarial field who are more qualified than I.
That said, the book just makes it very clear that the RR for a fully funded plan in the actuarial discount rate, so that’s where I stop.
Intuitively however, it’s important to remember that a nominal bond includes an inflation assumption.
HM
Pages