Hi there-working through some old questions and im just having a mental block on questions like this. Can someone provide better answer than what is provided below? I am sure its simple - but that doesnt mean i get it after months of reading this cr*p. Thx. Q. Company with pension fund has pension liability w/ duration of 10.1, and pension assets (FI portfolio) with duration of 6.1. Benchmark for FI portfolio is 5.5. Given the term structure of rates and the mismatch between duration of asset and liability, the plan sponsor should be most concerned about: A. flattening of the yield curve. B. steepening of the yield curve. C. large parallel shift up in the yield curve. ANSWER _________________________ A is correct. Given the mismatch in the liability and the benchmark they are running against, a flattening of the yield curve would cause the liability to increase faster than the asset
Flattening of the yield curve means a fall in interest rates. As the liabilities have a longer duration, they will increase in value by more than the liabilities, which is a BAD thing.
Thank you – so does the Bmark play into this or is it simply to add insult to injury that i didnt know this…
How about large parallel DOWNWARD shift up in the yield curve ? Liability will increase much more than asset, right ?
newsuper Wrote: ------------------------------------------------------- > Flattening of the yield curve means a fall in > interest rates. Why flattening of the yield curve means a fall in interest rates ?
I think the point was that any DOWNWARD movement in YCurve is bad when your liabilities are more sensitive to rates than assets. Parallel vs flattening --> hard to tell. Its relative i think. Thanks all.
Another crap question. This question implicity assumes that yields were upward-sloping (normal)…they could very much well be inverted, in which case the opposite happens. In general though, the yield curve is upward sloping, so a flattening of the curve would yield the same results as what newsuper said.
AMC - I think so
The question is not seriously written !
newsuper Wrote: ------------------------------------------------------- > AMC - I think so Please advise which part ?
^ he meant flattening of the yield curve = decrease in rates…Like I mentioned, this occurs when you have a normal upward-sloping yield curve.