U.S.-based Gwartney International (GI) is a financially healthy, rapidly growing
import/export company with a young workforce. Information regarding GIĂ˘â‚¬â„˘s definedbenefit
pension plan (which is subject to the Employee Retirement Income Security Act
[ERISA]) appears in Exhibits 3-2 and 3-3.
In accordance with GI policy, the plan discounts its liabilities at the market interest
rate for bonds of the same duration. GIĂ˘â‚¬â„˘s risk objectives include a limitation on volatility
|Asset Class||Actual and Target Allocation||Prior-Year Total Return|
|Large-Cap U.S. Equities||35%||10.0%|
|Small-Cap U.S. Equities||10%||12.0%|
|U.S. Treasurey Bills (1-year Duration)||10%||4.5%|
|U.S. Intermediate-Term Bonds and Mortgage Backed Securities (4-Year Duration)||17%||1.0%|
|U.S. Long-Term Bonds (10-Year Duration)||23%||19.0%|
|Total Fixed Income||50%|
*Income element 7.0%; price gain element 12.0%.
|Present Value of Plan Liabilities||$ 298,000,000.00|
|Market Value of Plan Assests||$ 300,000,000.00|
|Duration of Liabilities||10||Years|
|Actuarial Return Assumption||7%|
|GI Board’s Long-Term Total Return Objective||9%|
Giselle Engle, the newly appointed CFO, must explain to the board of directors why
the surplus declined in a year when the actual investment return was 100 basis points
more than the long-term objective stated by the board.
A. Explain how the plan surplus could decline in a given year despite an actual return in
excess of the long-term return objective.
B. Explain the importance of an appropriate investment time horizon when setting
investment policy for GIĂ˘â‚¬â„˘s corporate pension plan.
C. Discuss the risk tolerance of GIĂ˘â‚¬â„˘s corporate pension plan.
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