MSIM In Class Assignment #3 as adapted from previous CFA exam question

The following question has three parts, (A, B, C) for a total of 26 minutes

ABC Manufacturing is the leader in industrial constructionequipment. The company has several major competitors, but maintains a leadership role through brand recognition and customer loyalty. Profits doubled in 20X5 over the 20X4 period and the firms market capitalization now stands at $50 billion. ABC has both domestic and non-U.S. defined benefit pension plans covering substantially all of its U.S. employees and a portion of its non-U.S. employees, primarily in European facilities.

ABC has recently hired Jane Alter, CFA, to manage the U.S. portion of ABCs pension plan (ABC-PP). Janes initial research on ABC concludes that ABC is financially sound with a higher return on equity and a lower debt to equity ratio than the industry averages. She also learns that ABC has added 8,500 new hires to the company over the last two years. These new hires have primarily been entry level administrative, technical, and manufacturing workers; this has resulted in lowering the average age of the workforce. The active labor force now stands at slightly over 85,000. There are no early retirement buyouts planned.

Jane holds a meeting with Richard Long, ABCs CFO. Long indicates that the plans investment objective is to be fully funded within five years without any contributions from the fund sponsor. He believes this goal is attainable without assuming more risk than the plan is willing and able to take. He also indicates his confidence that the current construction boom will continue for at least five years, and would like to increase plan assets invested in the industrials sector from its current 10% level to 15% of equity assets.

Jane constructs the following exhibits to analyze the plans objectives and risk tolerance.

20X5 Selected Pension Plan Information (USD Millions)

Market value of plan assets$ 9,779

Projected benefit obligation$10,890

Discount rate 5.6%

Duration of pension liability18 years

Comparison of ABC to the Industrial Construction Industry

ABCIndustry Avg.

Active/retired employees80%/20%75%/25%

Average active employee age3546

Percentage of employees age >5010%20%

As a first step, Alter must prepare an investment policy statement (IPS) for the plan.

A. Formulate each of the following investment policy statement (IPS) items for ABC-PP:

1. Return Requirement

2. Liquidity Requirement

3. Time horizon

Justify each response with one reason. Note: Show your calculations for the formulation of the return requirement. Your responses for each IPS item should specifically address ABC-PPs circumstances.

(9 points)

Return Requirement (2 points for calculation, 1 point for justification)

Liquidity Requirement (1 point for explanation, 2 points for justification)

Time horizon (1 point for explanation, 2 points for justification)

B. Indicate whether each of the following factors increases or decreases ABC-PPs ability to take risk:

1. Risk exposures that are common to both the plan sponsor and stocks in the industrials sector (1 point)

Circle one: Increases/Decreases

Justify your response with one reason (3 points)

2. Increasing the workforce with younger workers (1 point)

Circle one: Increases/Decreases

Justify your response with one reason (3 points)

C. Indicate whether ABC PP has below average, average, or above average ability to assume risk relative to the average firm in the industry for each of the following factors (9 points):

i. ABCs financial condition (1 point):

Circle one below average/average/above average

Justify your response with one reason (2 points):

ii. Workforce age (1 point):

Circle one below average/average/above average

Justify your response with one reason (2 points):

iii. Retired employees (1 point):

Circle one below average/average/above average

Justify your response with one reason (2 points):