3. Continued
(d) Assume through 2004 that no assumptions have changed from 2003. Assume that
on January 1, 2005, there are defaults within the investment portfolio which
reduce future investment income to NADA by 0.20% per annum. Calculate the
impact that this event will have on NADA’s balance sheet and income statement
for the GIC business originally written in 2003. Show your work.
(e) Following your GIC analysis, you consider the implications of Von Nostrum’s
recommendation for NADA’s other business lines.
Explain the likely reasons why Von Nostrum has recommended deferring
acquisition costs, and describe the considerations impacting the capitalization and
amortization of acquisition costs associated with each of NADA’s business lines.
4. (3 points) Outline a report analyzing the strengths and weaknesses of NADA’s corporate
governance system.
5. (9 points) NADA is currently under review with negative implications by the J.
Peterman rating agency.
(a) Describe which current operations and corporate attributes of NADA help to
maintain or improve its rating and which may hurt the rating.
(b) Propose changes to its business strategy that NADA can implement to improve its
rating. Include justification for your proposed changes.
COURSE 8: Fall 2003 5 GO TO NEXT PAGE
FINANCE
Morning Session
6. (4 points) XYZ Company uses the expected policyholder deficit as the relevant risk
measure for solvency analysis. XYZ’s total assets are currently $10,000 and have been
invested to earn a guaranteed return of 5% over the next year. XYZ has two lines of
business with perfectly correlated liability exposures. The total loss for the two lines
combined at the end of the year is a random variable that is distributed as follows:
x Pr[X=x]
$8,000 15%
10,000 60
12,000 25
(a) Calculate the expected policyholder deficit ratio. Show your work.
(b) If the regulator requires that capital be held such that the expected policyholder
deficit does not exceed 5% of expected losses, determine XYZ’s current position
relative to this requirement. Show your work.
(c) Describe how the owners of XYZ hold a position similar to a stock option.
7. (8 points) As the Product Innovator at In the Box Co., you developed an idea for a new
product line and pitched it to your boss, Jack, who is the Vice President of Marketing.
Thinking this concept is a good strategic fit and recognizing value based on features
already traded in the market, Jack requests that you develop the idea further.
You use the traditional discounted cash flow (DCF) approach to analyze the idea.
Unfortunately, you discover that this project produces a NPV of 50 using the DCF
approach.
(a) Explain why Jack’s initial assessment of the project does not seem to reconcile
with the value calculated under the traditional DCF approach.
(b) Describe how you would enhance the DCF approach to consider the additional
value that Jack sees.
(c) Indicate the complications presented by the approach you proposed in part (b).
COURSE 8: Fall 2003 6 STOP
FINANCE
Morning Session
8. (6 points) As a financial consultant to Golden Parachute Company, you have been asked
to make a recommendation to the Board of Directors regarding the funding of the
company’s defined benefit pension plan. The board is split between those that feel the
plan is too heavily funded (and would like to take a plan reversion) and those that feel the
funding status of the plan is not sufficient due to the level of equity exposure. A law has
just been passed that will prevent companies from taking a pension plan reversion, but it
does not become effective until the next plan year.
You have the following information available:
•Market value of plan assets = $65,400,000
•Present value of liability by accounting standards = $60,000,000
•Present value of liability by actuarial standards = $63,000,000
•Assumed rate of return for plan valuation purposes = 8.5%
•Plan early retirement provis ion(s) = none
•Plan normal retirement age = 65
•Amount of liability by accounting standards attributed to employees age 60 or older =
$36,000,000
•Minimum required contribution for the plan year in question = $0
•Maximum tax-deductible contribution for the pla n year in question = $1,000,000
•Asset Allocation: 50% Stocks
25% High yield bonds
20% Municipal bonds
5% Cash
Upon a participant’s retirement, the plan liquidates assets to purchase a life annuity to
cover the participant’s future benefit payments.
(a) Outline the advantages and disadvantages of overfunding a defined benefit
pension plan.
(b) Recommend the funding related action that Golden Parachute’s Board of
Directors should take. Support your recommendation.
(c) Recommend whether any changes should be made to the asset allocation or
assumptions utilized in the pension plan’s annual valuation. Include support for
your recommendation.
**END OF EXAMINATION**
MORNING SESSION
COURSE 8: Fall 2003 - 7 - GO ON TO NEXT PAGE
Finance
Afternoon Session
**BEGINNING OF EXAMINATION**
FINANCE
AFTERNOON SESSION
Beginning With Question 9

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