the formula for interest cost is PBO at beg of period x discount rate then, the Pension Plan Assumptions chart in Schweser goes on to say that an INCREASE in the discount rate will DECREASE interest cost (and thus pension expense…in most cases). Seems very counterintuitive to me. What am I missing? Surely that’s not a typo. Thanks
It is because you are discounting back PBO with this rate. The higher the rate assumption, the smaller the present value of your future obligation.
another pension question: what’s beginning market-related value used in calculation of expected return on assets?
maratikus Wrote: ------------------------------------------------------- > another pension question: > > what’s beginning market-related value used in > calculation of expected return on assets? I have struggled with this too. I feel that it is HIGHLY unlikely that it will be test as the CFAI text barely touches on it, but here is my take: Beg market-related value + Expected rtn of plan assets +Employer contributions -Benefits paid +/- 20% of the last five years’ deferred asset gains/losses*** ____________________________________ =Ending market related value When the pension plan first started fair value and beg market-related value were equal, but over time the will not be. This is due to the deferred asset gains or losses being amortized in and averaged into the calculation. The amount amortized in is the difference between actual returns on assets and expected***. It is spread over 5 years. This is done because if you used and expected return as a percentage return (say 10%) but then mutiplied it by your plan assets (say $10 M) = $1M. Say in year two your plan assets drop to $9M. Pension epense would be 900,000. These would be the value used as EXPECTED RETURN on the IS. This is inherently flawed because the plan assets will vary wildly with actual return causing the $ expected return to vary wildly. So the market related value is used instead. The 10% expected return will be multiplied by and averaged asset base and it will smooth out the dollar amount reported on the IS each year.
thanks mwvt9. that was very helpful!
good stuff mwvt. thanks