FI.Chapter2 - I l. l[ r ] . iiii r{ !4UI.u | :.:,.I Tinre...

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I l.l[r ] .iiii !!4U I.u r{ | :. .::,.I Tinre Velue ef &Toney n 2006, the U.S. pension syslen was significantly underfunded-companies in ihe S&P 500 ncedcd an additional S-10 billion lo cover their pcnsion coDrrit- ments. This same siluation existod in thc U.K. and many other nations. Several f:,. tors contribuied to this problen, includjng questionable applications of ihc time value First, note tirnt there are two iypcs of pension pLans-"defined contribution plans," r'here a companv provdes a spe- cific anount of money, oltcn basccl on prof- its, to h€lp its €mployees lvhen thcv retifc, and "defined benefit plans," i{'herc thc company promises to make sp€cific lifrtin]c pensiorl paymerts b employces when they retire. The payments dopend on eacil employee's final pay at retireNcnt, ycars of qcrvice \^'ith the company, and how long thc cmployees live. Actuaries can estimatc ilese faciors, but thc company's frture obli- gations still are u ccrtain urdcr a tlefined benefit plan. As wc noted nl Chapter 1, a dollar flrturc is r\,orth less thtrn a dollar bday. U.rn; rhr tirrrr r,'lu, nf m.'r,y lool' In rhi. .hrpler hc ,.',r r.r'T,,1! l,ns nr|r(h ir n€€ded today to rnak€ ih€ prorniscd fL!tufc pi)rcrr. . The .rmou|lr r,r,d.'d t,'d.,) i- aciually tho present vahe of ih€ futurc paymcnts. This prcscnt value is callcd Lhc "pensiorr liabjlity," bccausc jt lcpresents a clann aBainst the cornpany. Under our pen- -r,.r l,,w-. lhp,ompdr\ r! -uppo-ed lu ,Hr asidc'c'rrough money each year to neet these futurc claims. The amount of mone,v lh.rl i,,. bcLr.yi .t.idq, u hirh i. in\.'lFd in a portfolio of stocks. bonds, real estaie, and othcr assets, is called the "pension assei." lf thc'pclrsion asset is lL'ss than the pension liability, thcn a defined benefit plan is said to be underfunded. Wh(n .r ,orrfdny wrth rn undertund"d penn,'n pLn 8oc" b.rnlrupl. the pen5ior uL'li- drlhrrlr.rrf r.\umcJ by the lenrior Benerrt Cu:rantcc Corporrtbn, a government agency tlut is implicitly ba(kcd by thc U.S. govern mcnt, which menns taxpnver5. Whcn many ','mp.rnr(. .,R Lu,LlerfundeJ. .' !e v ,e.i pu* !hrlry,\rst. th.r ),,u. n- a tr\p.,\er \ill h,ru l'' b.ril 'irl lh( sy-rL m. Nule loo lhd, lir'. its exist on the paymcnts kr cach employee, so if you are highly paid and ),our cmployel gocs bankrupt, you will also be a loscr. How docs the time valLre of monev fit jnto all this? ft scc thc connection, slrppose a pl,rr,: pen.i.,r .r.\1, ,r', :nir.,rll) e\.r,'l\ cqual to its liabiljLies, and thcn intcrest rates dccline. As you will see, fallirlg intercst ratcs (aLrse the present value of liabilities k) incrca$c. Sinrultancouslt the future eaning power of thc pcnsion asscis will probabl)' be n rlucecl. - ' rrrle'. thq . ,.nrp.,ny in.r.d- ,,. anrlral conlribulions thc plan will bccome urJ({turd( J. Thr- i" e\.,, Ll} \hrll,.,tprrc.l
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durhg the carly 2000s. hrtercst rates fell, pension plans bccame under fonded, companies that wer€ having opcrating tiroblerns were Lrnable k) rncct thejr funding rcquireDrenis, and as a result many companics failed. This is but one of th€ many uses of timc value anal)'sis, but keep thc pen sion fund example in mind ns you go thnugh the chaptcr
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This note was uploaded on 06/08/2009 for the course FI 601-602 FI601-602 taught by Professor Prof.geary during the Spring '09 term at New Haven.

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FI.Chapter2 - I l. l[ r ] . iiii r{ !4UI.u | :.:,.I Tinre...

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