Concerning question 3 can someone explain why answer C) $18million is the correct answer…
it is clear that we have to add deferreds and active accrued because both are not inflation indexed and therefore have to be mimicked with nominal bonds…for me it is not clear why we should incorporate future wage inflation and future real wage growth…these are inflation indexed items that are normally hedged with real rate bonds (see question 2)
concerning question 6, why is answer b) incorrect? the explanation in the solution does not help me very much…
appreciate your comments
Read the text.
Silva presents Exhibit 1, noting that approximately half of the future wage inflation liability is assumed to correlate closely to CPI and half of the future real wage growth is assumed to correlate closely with domestic equities:
so only 50% is, the remaining 50% is NOT.
Part 2 - Q 6:
Using real and nominal bonds - would mean you need to buy them for your portfolio. Cost of that process would be much higher than using derivatives.
Cash usage is the same
A) says in a Asset only approach
b) says in a well-diversified return- generating portfolio.
difference is in the cost of the “bonds” vs. “derivatives”, I think.
concerning part 1 it is clear that only 50% have to be accounted for, but my question is why at all we have consider these two positions…my solution was without any future real wage growth and future wage inflation because my thinking is that nominal bonds are used as hedge only for no inflation indexed parts…
50% is indexed to Inflation and 50% is not.
the part that is not inflation indexed needs to be mimicked by nominal, doesn’t it?
deferred + accrued + 50% of the remaining (Future Wage Growth + Future Wage Inflation)