DB plan

cfai book #2, p373 - 374, q4 (1994 cfa l3 exam) can someone help me out on how to back out discount rate for a pension liability based total return of long-term treasury and inflation rate? background info given by the question: 1929 - 1993, total return = 5.0%; inflation = 3.2% 1984 - 1993 (recent period), total return = 14.4%; inflation = 5.5%. 1994 - 2000 (forecast), total return = 6%; inflation = 6% current discount rate = 8%, above info indicates it should be 6 - 7% (why/how?)

If you look at the consensus forecast you’ll see that long-term treasuriers are at 6%. which gives the lower bound for what the appropriate discount rate should be. the appropriate discount rate would be a long term bond of high quality. So a 6% rate would be fine. If we didn’t have treasuries to work with, you could make a case for AAA bonds. In the case of this quesiton, inflation is already embedded in the 6% long term treasury returns, so inflation is extra information to throw you off.

cool, i think you are right. so, can i say that consensus forecast of the “total return” is on the income only, there should be no capital gain involved? anyway, thanks,

total return implies, by definition, both income and capital gains.

well, if that is the case, should one strip out capital gain piece from the total return to come up a ture discount rate? say my 10-year bond is up 10% with 4% attributed to capital gain, then should someone use 6% as discount rate for a 10-year liability?