Ability to take risk - 2009 3.B.i

CFA Level III
#1

The answer to the question says that the Foundation established by the company has a greater ability to take risk since it has a spending target which is set in order to minimize taxes, which is in contrast to the pension plan, which has to pay defined benefits, which is a legal liability.

However, the question also mentions that the company does not intend to make any additional donations to the Foundation in the future, but is in a good enough financial position to make additional contributions to the pension plan if required.

Since the foundation won’t be getting any additional money from the sponsor (but can solicit for donations from external parties) but the pension plan will get contributions if required, doesn’t that increase the ability of the pension plan to take risk?

#2

The foundation’s spending is a percentage of its assets, so whether it gets funding or not has no effect on its risk tolerance.

The pension plan’s spending is independent of its assets, so lack of funding or return is a problem. And while the company can make contributions to the plan now, it may not be able to do so in the future, should circumstances change for the worse.

#3

So is it fair to say that the ability to take risk is determined more by whether or not it can scale down spending without affecting beneficiaries rather than by the ease of ability to make up for losses in the investable base?

#4

I’m not sure that that’s it in its entirety, but I’d say that it’s a great way to look at it.

(Note to self: you should have thought of that.)

#5

Alright, thanks S2000!

#6

My pleasure.