After reading the Novy-Marx and Rauh article (see the Common Mistake Box on page 159), you decide to compute the total obligation of the state you live in. After some research you determine that your state’s promised pension payments amount to $10 billion annually, and you expect this obligation to grow at 2% per year. You determine that the riskiness of this obligation is the same as the riskiness of the state’s debt. Based on the pricing of that debt you determine that the correct discount rate for the fund’s liabilities is 3% per annum. Currently, based on actuarial calculations using 8% as the discount rate, the plan is neither over- nor underfunded––the value of the liabilities exactly matches the value of the assets. What is the extent of the true unfunded liability?
Answer to relevant QuestionsA 30-year bond with a face value of $1000 has a coupon rate of 5.5%, with semiannual payments.a. What is the coupon payment for this bond?b. Draw the cash flows for the bond on a timeline.What is the price of a five-year, zero-coupon, default-free security with a face value of$1000?Explain why the expected return of a corporate bond does not equal its yield to maturity.Suppose you wanted to lock in an interest rate for an investment that begins in one year and matures in five years. What rate would you obtain if there are no arbitrageopportunities?You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a year to build and cost $100 million upfront. Once built, ...
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