Schweser indicates that an increase in the interest rate decreases interest cost because since int cost=PBO*discount rate, the PBO decreases faster than the discount rate increases so int cost decreases, WITH THE EXCEPTION OF MATURE PLANS where the int cost might increase. But question 15 afternoon on the CFAI mock says that normally an for an increase in the discount rate: “It will increase the int expense component of pension expense, but typically the decrease in the present value is greater than the increase in the int component; the exception is when the PENSION OBLIGATION IS OF SHORT DURATION.” Bottom line: Does the increase in discount rate lower the interest cost on average or raise it?
if short duration, the discount value of PBO is smaller than interest expense increase caused by discount value increase If long duration, the discount value of PBO is larger than interest expenses increase caused by discount value increase, since the base is significantly reduced Is that right?
long duration: interest goes up service cost down interest cost down pension expense down short duration interest goes up service cost down interest cost up —> this can lead to an increase in pension expense danm… now i am confused… does this make sense?
But what constitutes “short period?” I want to know what the “normal” effect is on interest expense from an increase in the discount rate, cause that’s what they’ll ask.
short i’d say less then 10 years.
normal response without too much into it increase in Discount rate decrease interest expense because PBO would be lower