a.
To determine:
To develop an investment policy statement for a pension fund described as a mature defined benefit plan with the workforce having average age of 54 years, no unfunded pension liabilities and wage cost increase
Introduction:
An investment policy statement (IPS) is defined as a document drafted for a
a.
Answer to Problem 1PS
The objectives and constraints related to pension fund are mentioned.
Explanation of Solution
Given Information:
Given that a pension fund described as a mature defined benefit plan with the workforce having average age of 54 years, no unfunded pension liabilities and wage cost increase forecast at 5% annually.
In defined benefit plan, investor receives an assured pension amount irrespective of the return that is generated by the pension fund. In this kind of retirement plan, the total value of pension amount or the retirement benefit is recognized in advance.
The two major objectives of pension fund are to increase its return requirements and risk tolerance. If the pension fund's actual return exceeds the assumed actuarial return, the shareholders will reap profits. The risk tolerance level of the pension fund depends on proximity of payouts.
Constraints usually co-relate with investor circumstances. These circumstances include liquidity, investment horizon, regulations and tax consideration. For pension fund, if the pension fund is young, the liquidity should be low and vice versa. Investment horizon should be long and pension fund is not liable to any tax rates.
b.
To determine:
To develop an investment policy statement for a university endowment fund described as conservative, with investment return being utilized along with gifts and donations to help meet annual expenses. The spending rate is 5% per year and inflation in costs is expected at 3% annually.
Introduction:
An investment policy statement (IPS) is a document drafted for a portfolio manager by his client that outlines general rules for investment for the manager. This statement gives the broad investment objectives and constraints of a customer and illustrates the strategies to be formulated by the manager for meeting these objectives.
b.
Answer to Problem 1PS
The objectives and constraints related to university endowment fund are mentioned.
Explanation of Solution
Given Information:
Given that a university endowment fund described as conservative, with investment return being utilized along with gifts and donations to help meet annual expenses. The spending rate is 5% per year and inflation in costs is expected at 3% annually.
An endowment fund is usually created by a foundation. The foundation makes withdrawals from the capital invested in the endowment fund. Such capital is used by the University for its general or operating needs. They are normally funded by donations.
The two major objectives of endowment fund are to determine its return requirements and risk tolerance. The return requirement is henceforth determined by current income needs and need for assets growth to maintain the real value. As given in the question itself, risk tolerance is generally conservative.
Constraints usually co-relate with investor circumstances. These circumstances include liquidity, investment horizon, regulations and tax consideration. Endowment funds require low level of liquidity and long time horizon with no rate of tax applicable.
c.
To determine:
To develop an investment policy statement for a life insurance company described as specializing in
Introduction:
An investment policy statement (IPS) is a document drafted for a portfolio manager by his client that outlines general rules for investment for the manager. This statement gives the broad investment objectives and constraints of a customer and illustrates the strategies to be formulated by the manager for meeting these objectives.
c.
Answer to Problem 1PS
The objectives and constraints of a life insurance company described as specializing in
Explanation of Solution
Given Information:
Given that a life insurance company described as specializing in annuities, policy premium rates are based on a minimum annual accumulated rate of 7% in the first year of policy and a 4% minimum annual accumulation rate in the next five years.
A life insurance company invests to hedge their liabilities, which are defined by their own policy.
The two major objectives of insurance company are to determine its return requirements and risk tolerance. The return requirement should exceed new money rate by sufficient margin to meet the expenses and profits. Also for insurance company, actuarial rates are necessary to be determined. As given in the question itself, risk tolerance is generally conservative.
Constraints usually co-relate with investor circumstances. These circumstances include liquidity, investment horizon, regulations and tax consideration. Life insurance requires low level of liquidity and long time horizon with the rate of tax applicable.
Want to see more full solutions like this?
Chapter 22 Solutions
EBK ESSENTIALS OF INVESTMENTS
- Eccles Inc., a zero-growth firm, has an expected EBIT of $100.000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. What is the firm's cost of equity according to MM with corporate taxes? Ο 32.0% Ο 25.9% Ο 21.0% Ο 28.8% Ο 23.3%arrow_forwardP&L Corporation wants to sell some 20-year, annual interest, $1,000 par value bonds. Its stock sells for $42 per share, and each bond would have 75 warrants attached to it each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds with-warrants at par? a. 9.54% b. 8.65% c. 9.08% d. 8.24% e. 83%arrow_forwardPotter & Lopez Inc. just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant? Ο $4.35 O $3.76 O $4.56 O $4.14 O $3.94arrow_forward
- If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that The dividend payout ratio is decreasing. The dividend payout ratio has remained constant. The dollar amount of investments has decreased. No dividends were paid during the year. the dividend payout ratio is increasing.arrow_forwardq6) Which of the following statements is CORRECT? If Congress increases taxes on capital gains but leaves tax rates on dividends unchanged, this will motivate companies to increase stock repurchases. The clientele effect explains why firms change their dividend policies so often.. One advantage of the residual dividend policy is that it helps corporations to develop a specific and well-identified dividend clientele. If a firm splits its stock 2-for-1, then its stock price will be doubled. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm's dividend payout.arrow_forwardAmold Rossiter is a 40-year-old employee of the Barrington Company who will retire at age 60 and expects to live to age 75. The firm has promised a retirement income of $20.000 at the end of each year following retirement until death. The firm's pension fund is expected to earn 7 percent annually on its assets and the firm uses 7% to discount pension benefits. What is Barrington's annual pension contribution to the nearest dollar for Mr. Rossiter? (Assume certainty and end-of-year cash flows. a. $3,642 b.$4,443 c. $4,967 d.$5,491 e.$2,756arrow_forward
- Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt. However, the CFO is considering moving to a capital structure with 30% debt and 70% equity. If the risk free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity? Ο 1.53% Ο 2.05% Ο 1.70% Ο 1.87% O 2.26%arrow_forwardThe common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond? a. $825.00 b.$866.25 c. $744.56 d. $783.75 e. $707.33arrow_forwardBailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta? a. 0.79 b. 0.71 c. 0.67 d. 0.64 e. 0.75arrow_forward
- Eccles Inc., a zero-growth firm, has an expected EBIT of $100.000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. What is the value of the firm according to MM with corporate taxes? a. $710,875 b. $587,500 c. $646,250 d. $475,875 e. $528,750arrow_forwardMikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00 and has an expected constant growth rate of 5%. The company is considering issuing a 10-year convertible bond that would be priced at $1,000 par value. The bonds would have an 8% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. What is the estimated floor price of the convertible at the end of Year 3? a. $926.10 b. $794.01 c. $835.81 d. $879.80 $972.41arrow_forwardMs. Lloyd, who is 25 and expects to retire at age 60, has just been hired by the Chambers Corporation. Ms. Lloyd's current salary is $30,000 per year, but her wages are expected to increase by 5 percent annually over the next 35 years. The firm has a defined benefit pension plan in which workers receive 2 percent of their final year's wages for each year of employment. Assume a world of certainty. Further, assume that all payments occur at year-end. What is Ms. Lloyd's expected annual retirement benefit, rounded to the nearest thousands of dollars? a. $116,000 b. $35,000 c. $89,000 d. $57,000 e. $132,000arrow_forward
Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education