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  #1  
Old 10-21-2019, 09:14 AM
schmittderek schmittderek is offline
 
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Default Spring 16, #5c (notional principal)

I donít understand the SOAís answer (375 million) to this question. How can the interest rate risk be minimized if the answer ignores the size of the PBO (600 million)?

Letís say interest rates decrease by 100 bps. Then:
PBO increases by 600 x .14 = 84
F.I. Allocation increases by 500 x 40% x .05 = 10
Swap value increases by 375 x .16 = 60

Thatís a net funded status change of 14. We could have achieved exactly 0 with a notional principal of 462.5 instead of 375.

What am I missing? Thanks in advance.
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Old 10-21-2019, 04:13 PM
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It comes down to how the question is worded. This question ask to, "...minimize the interest rate risk on the funded status of the plan". This is achieved with by the solution:

Current Funded Status = 500/600 = 83.33%
Your example funded status = (500+10+60)/(600+84) = 83.33%

On fall 2017 Q 3(c), the question ask, to "...fully hedge the plan’s interest rate risk". This question requires hedging the total PBO.
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Last edited by Prob4Fun; 10-21-2019 at 06:08 PM..
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Old 10-22-2019, 09:42 AM
schmittderek schmittderek is offline
 
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I see. Thanks so much for the response. Thatís a poorly worded question IMO.
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Old 10-23-2019, 12:18 PM
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Quote:
Originally Posted by schmittderek View Post
I see. Thanks so much for the response. Thatís a poorly worded question IMO.
Agreed. It doesn't help that the actual reading assumes the plan is 100% funded and does have an example when it's not.
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