Violume 2 CFAI, Page 505 Q 6

CFA Level III
#1

The related text book page is 499 bottom half of the page.

Anyone can tell me what is wrong with the choice B?

#2

Here is my response based on Schweser book 2 page 58 last paragraph.

Cordosa specifically requests that the solution should minimize the cost or probability and amount of company’s future contributions to the Pension Plan. The solution should also hedge the market related pension liability.

  1. So, as mentioned in option B, nominal and inflation bonds will hedge the market related pension liability, but this strategy is very expensive as this will eat up almost all the liabilities and leave very little asset for active management and for earning surplus return.

  2. Also, as mentioned in option B, investing the surplus in a well diversified portfolio is not the way to maximize your excess return. You need active management to earn active return.

Option A addresses both of these concerns.

  1. Option A hedges with derivates which are less expensive. (derivatives such as bond futures)

  2. Option A invests the remaining cash using an asset only active approach.

So, option A is the best answer.

Hope this helps.

#3

thank you~