if the pension is usually primarily invested in equities, why doesn’t that result in a higher Beta? and if you can answer those questions, can you please explain Schweser Book 2 page 65 question 4 to me? how does the math work out on the D/E being understated without the pension assets? Thanks!
Ahhh, having bad flashbacks tot he WACC question on last year’s exam.
The text-book version states… Usually pension assets are heavily invested in bonds and use ALM strategy. Thinking about the continuous pension payment liquidity needs and the regulations that prevent the plan to take too much risk. Unless explicited noted in the Q, we would assume the pension assets have a lower beta. Is there a particular Q in the text that has an Equity-heavy pension asset? Pension assets and liabilities are considered off-balance-sheet financing. You can get more details from the following investopedia (I don’t think you need to know it though) http://www.investopedia.com/university/financialstatements/financialstatements9.asp The balance sheet only reports a net amount of Plan funded status (plan asset minus plan liabilities) in the equity section. If you break it out into plan assets and plan liabilities, then add them to firm assets and liabilities, respectively – as a result both total assets and liabilities will increase. I am sorry that I don’t have Sch. book 2 with me right now but I think this probably answers your Q.
dpcfa Wrote: ------------------------------------------------------- > if the pension is usually primarily invested in > equities, why doesn’t that result in a higher > Beta? > > and if you can answer those questions, can you > please explain Schweser Book 2 page 65 question 4 > to me? how does the math work out on the D/E being > understated without the pension assets? > > Thanks! Why are you assuming that the pension is “usually primarily invested in equities”? Even though they take on decent risk in small buckets (PE, hedge funds, etc.), they’re still going to have a large chunk in fixed income for the lowered volatility and for the steady coupon payments to handle their current liabilities. Now knowing that, do you still have a question? If your pension plan has more debt (as a %) than your operating assets, obviously excluding it from your WACC calculation is going to lead to a WACC that’s too high and you’ll exclude projects that you shouldn’t.
if what you guys are saying is right, then i understand and it makes sense. If you look at schweser book 2 page 64, the review for LOS 22.b says “the level of the pension assets and liabilities should be used in determining the firm’s operating WACC in order to separate the risk of the firm’s assets, WHICH ARE USUALLY PRIMARILY INVESTED IN EQUITIES, from the risk of its business operations.” (i capitalized the letters, not schweser) is what they wrote a mistake? or am i missing something?
dpcfa Wrote: ------------------------------------------------------- > if what you guys are saying is right, then i > understand and it makes sense. > > If you look at schweser book 2 page 64, the review > for LOS 22.b says “the level of the pension assets > and liabilities should be used in determining the > firm’s operating WACC in order to separate the > risk of the firm’s assets, WHICH ARE USUALLY > PRIMARILY INVESTED IN EQUITIES, from the risk of > its business operations.” (i capitalized the > letters, not schweser) > > is what they wrote a mistake? or am i missing > something? Yes, that is an error on Schweser’s part (as evidenced by the two phrases in the same sentence directly contradicting each other). See the bottom of page 60 for the “real” answer: “The main thrust of this material is that the firm’s WACC is usually overestimated, unless management explicitly considers the assets and liabilities held in the pension plan.”
n/m
read page 60 of that same section dpcfa. The “risk” they’re talking about is beta, and if you use a weighted average of beta on debt & equity the debt will drop out as it has a beta of zero.
“in order to separate the risk of the firm’s assets, WHICH ARE USUALLY PRIMARILY INVESTED IN EQUITIES,” It seems schweser is talking about risk of firm’s assets ? Not pension assets, in that case, is it not right?
I read schweser and agree with everyone else, it’s primarily invested in debt. You must not have read it carefully. Give it another read through, I’m guessing you missed something.
Just read the CFAI text section on this. The Schweser passage is nearly useless.
I read Schweser a while back and agree that it says plans primarily invest in debt and have lower beta. However, the following would have been wrong in the note – “the level of the pension assets and liabilities should be used in determining the firm’s operating WACC in order to separate the risk of the firm’s assets, WHICH ARE USUALLY PRIMARILY INVESTED IN EQUITIES, from the risk of its business operations.” No matter how I read the phrase whether it refers to plan or firm assets, it doesn’t make sense. I think the firm assets usually have a high beta because of operations risk sensitivity to the economy. I am going to check the Schwezer book pg. 64 tonite; I may have missed this error when I first read it long time ago. Perhaps the Schwezer writer and editor had a random fire-drill in the building when they completed this SS.
FRM2cfa Wrote: ------------------------------------------------------- > “in order to separate the risk of the firm’s > assets, WHICH ARE USUALLY PRIMARILY INVESTED IN > EQUITIES,” > > It seems schweser is talking about risk of firm’s > assets ? Not pension assets, in that case, is it > not right? lol - if i was gonna forget to write a word, i picked the worst word to forget - pension. it says - "“in order to separate the risk of the firm’s PENSION assets, WHICH ARE USUALLY PRIMARILY INVESTED IN EQUITIES,”
I think we can all agree that it’s an error on Schweser’s part - I was actually going to report it yesterday, then got lazy.