Schweser, V2, page 53. Can someone explain this to me in simple terms. I didn’t follow it in the other thread and I can’t get my head around the concept in the way schweser presents it. Grrr.
The key to understanding this stuff is the link between market beta and operational beta (unlevered beta). You’ll need to go back to L2 stuff to see the formulas and explanation if you’re not clear on this. (To be honest, this is on my to do list, so as of now I’m not 100% understanding this stuff either.) Once you get that, all that Reading 22 is saying is, when you unlever your beta, count pension liabilities too, even though they’re not explicitly on the b/s, they should be considered debt as well.
The corresponding reading in the CFAI text is probably the best of all - I really enjoyed reading it. And it is short. Worth a read.
Is the equation or what? The equation on page 52 is to show you why WACC is lower once pension asset is incorporated into the WACC calculation. The idea is total firm asset is made up with operational asset and pension asset, therefore, total firm beta is the weighted average of pension asset beta and operation asset beta. Firm’s operational asset beta is what you need to figure out the WACC for the firm, to once you figure out what the total firm’s beta, you can back out what the firm’s operational beta is. Helps? Let me know. Thanks
On page 53… There are the assuption Schweser uses, Total firm asset = Pension aset + operation asset. Use of equity holding(stock) increase pension asset’s riskiness. Use of equity (stock) in financing operational asset reduce operaion asset’s risk. So, if you use too much equity in pension asset (increase risk), you need to balance out the total firm’s asset in operation asset by use more equity or hold less debt (reduce risk). If you use more debt in your pension asset (less risk), you need to balance out the total firm’s asset in operation asset by use more debt (increase risk).
oh. boy. this is complicated! a cfa remedy for gm is to start issuing a lot more shares. if they don’t, it will be a violation of their fudiciary duty to investors. i am amused … 
Man, I thought I was done with that kind of stuff with L2. I definitely need to review.
rand0m Wrote: ------------------------------------------------------- > oh. boy. this is complicated! > > a cfa remedy for gm is to start issuing a lot more > shares. if they don’t, it will be a violation of > their fudiciary duty to investors. i am amused > … or reduce equity holdings in their pension plan…
i doubt they can do that given over 100,000 auto-workers’ pension is on-the-line (remember the return requirement thing?). on top of that, they also need to make further contributions to the fund to make the ends meet.
I just read the CFAI section on this… Still don’t get how they are comming up with some of the stuff… I am sure it wont bite me in the A$$ if I just remember without pension assets & Liabilities WACC will be over stated (Sarcasm)
hi ws I am confused by this statement. “If you use more debt in your pension asset (less risk), you need to balance out the total firm’s asset in operation asset by use more debt (increase risk).” more debt in pension -> less risk. more debt in operation asset -> more risk. Will that be contradicting? Can you pls help me to understand the concept? Thanks!
Pension asset is the true asset of the firm(in a sense). Think about when you build your personal investment portfolio, 100% stock vs 100% bond, which is less risker? Your 100% bond portofilo. Operation asset is asset, however, let’s think about our basic equation Asset=Equity+Liability. So, to finance your operational asset, a firm can raise equity or raise debt. We all know that increase debt financing in corp. finance structure can increase the riskiness of firm’s operation. However, issuing equity is less riskier. Does this help??
bravo! thanks for the prompt reply, ws!