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Chapter 29
Pension Plan Management
ANSWERS TO END-OF-CHAPTER QUESTIONS
29-1 a. Under a defined benefit plan, the employer agrees to give retirees a specifically
b. Under a defined contribution plan, companies can agree to make specific payments
d. The cash balance plan is a new type of retirement plan developed in the late 1990s. It
is like a defined benefit plan in some respects and like a defined contribution plan in
g. A pension plan is fully funded when the present value of expected retirement benefits
k. FASB provides firms with current guidance for reporting pension costs, assets, and
liabilities. For defined contribution plans, FASB rules require the annual contribution
to be shown on the income statement, with a note to the financial statements
l. Funding strategy for a pension fund involves two decisions: (1) how fast should any
m. The investment strategy for a pension plan deals with the question: Given the
n. Asset allocation models are used by pension fund managers to help plan funding and
o. The Jensen alpha is a numerical measure of a portfolio's performance as compared to
p. Tapping fund assets refers to usage of pension fund assets for a corporation's own
q. Health care benefits are offered by most companies as part of their retirement
packages, usually until the retirees reach age 65 and become eligible for Medicare.
29-2 Ideally, the employee will choose the plan that provides the incremental cash flows (both
costs and benefits) that maximize the employee's expected utility of consumption.
29-3 From an employer's standpoint, the defined benefit plan's major advantage is promotion
of low employee turnover. The economic consequences of job-changing are not desirable
However, there are several disadvantages associated with defined benefit plans. First,
the plan puts greater risk on employers, since it guarantees to pay employees a fixed
retirement benefit regardless of the firm's ability to fully fund the plan. Second, the
Defined contribution plans avoid many of the problems of defined benefit plans, since
future payments are based on the rate of return on the pension plan's portfolio.
The greater risks involved with a defined benefit plan are a major reason why, in
29-4 If the returns on these assets are less than perfectly positively correlated with the fund's
other assets, then the addition of such investments as foreign stocks and precious metals
29-5 a. Defined benefit plans carry with them economic incentive to discriminate against
b. There is an economic incentive for employers to discriminate against women in their
c. Defined benefit plans contribute to lower employee turnover that would reduce
training costs.
d. Pension benefits in a defined benefit plan are usually based on number of years
worked and either the final, or the last several years' salary. This means that unions
are more likely to work with a firm to ensure its survival, and thus ensure the survival
of the pension plan, if it has a defined benefit plan. However, the level of benefits
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
29-1 a. His wage in the final year of working is $179,700:
b. Assuming an actuarial rate of 10 percent, CC must accumulate $615,066 by the time
of Mr. Jones's retirement:
Annual retirement benefit = $53,066(0.01)(20) = $10,613.
We see that the older worker requires $1,409 - $856 = $553 more in annual pension
d. Ms. Brown would receive the same retirement benefit as computed for Mr. Jones in
Thus, the company is actually "paying" Ms. Brown more than they are paying Mr.
Jones. Whether this is equitable or not is a matter of debate.
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b. If the portfolio return was net of all transactions costs and management fees, then the
c. It would be impossible to predict next year's performance based on one year's
historical performance.
