704 Part Eight Risk Management
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- The websites of the major commodities exchanges provide futures prices. Calculate and plot
(as in Figure 26.2) the annualized net convenience yield for a commodity of your choice.
(Note: You may need to use the futures price of a contract that is about to mature as your
estimate of the current spot price.) - You can find swap rates for the U.S. dollar and the euro on http://www.ft.com. Plot the current
swap curves as in Figure 26.3. - You can find spot and futures prices for a variety of equity indexes on http://www.wsj.com. Pick
one and check whether it is fairly priced. You will need to do some detective work to find the
dividend yield on the index and the interest rate.
● ● ● ● ●FINANCE ON
THE WEBMINI-CASE ● ● ● ● ●
Rensselaer Advisers
You are a vice president of Rensselaer Advisers (RA), which manages portfolios for institutional
investors (primarily corporate pension plans) and wealthy individuals. In mid-2017 RA had about
$1.1 billion under management, invested in a wide range of common-stock and fixed-income port-
folios. Its management fees average 55 basis points (.55%), so RA’s total revenue for 2017 will be
about .0055 × $1.1 billion = $6.05 million.
You are attempting to land a new client, Madison Mills, a conservative, long-established
manufacturer of papermaking felt. Madison has established a defined-benefit pension plan for
its employees. RA would manage the pension assets that Madison has set aside to cover defined-
benefit obligations for retired employees.
Defined benefit means that an employer is committed to pay retirement income according to a
formula. For example, annual retirement income could equal 40% of the employee’s average salary
in the five years prior to retirement. In a defined-benefit plan, retirement income does not depend
on the performance of the pension assets. If the assets in the fund are not sufficient to cover pen-
sion benefits, the company is required to contribute enough additional cash to cover the shortfall.
Thus the PV of promised retirement benefits is a debt-equivalent obligation of the company.^35
Table 26.6 shows Madison’s obligations to its already retired employees from 2018 to 2036.
Each of these employees receives a fixed dollar amount each month. Total dollar payments decline
as the employees die off. The PV of the obligations in Table 26.6 is about $89 million at the cur-
rent (2017) 5% long-term interest rate. Table 26.6 also calculates the duration of the obligations at
7.8 7 ye a r s.
Madison has set aside $90 million in pension assets to cover the obligations in Table 26.6, so
this part of its pension plan is fully funded.^36 The pension assets are now invested in a diversified
portfolio of common stocks, corporate bonds, and notes.
After reviewing Madison’s existing portfolio, you schedule a meeting with Hendrik van Wie,
Madison’s CFO. Mr. van Wie stresses Madison’s conservative management philosophy and warns
against “speculation.” He complains about the performance of the previous manager of the pen-
sion assets. He suggests that you propose a plan of investing in safe assets in a way that minimizes
exposure to equity markets and changing interest rates. You promise to prepare an illustration of
how this goal could be achieved.(^35) In defined contribution plans, the corporation contributes to the pension fund on behalf of its employees. Each employee has a claim
on part of the fund, just as if the employee held shares in a mutual fund. Employees’ retirement benefits depend on their balances
in the fund at retirement. If the benefits fall short of an employee’s plans or expectations, he or she has no recourse to the company. 36
Madison must also set pension assets aside for current employees. For this mini-case, we concentrate only on retired employees’
benefits.