“The GIPS general provisions for real estate and for private equity require that both income and capital

“The GIPS general provisions for real estate and for private equity require that both income and capital

gains are included in the calculation and presentation of returns."

Regarding the comments by Rose and Boatman on the incorporation of pension plan risk into the weighted average cost of capital, determine whether they are correct or incorrect.
A . Only Rose is correct.
B . Only Boatman is correct.
C . Neither is correct.

View Answer

Answer: C

Explanation:

Both of the statements have correct and incorrect portions, so the answer is A, neither is correct. Rose starts off with a correct statement, when he says that pension assets should be included in the firm’s overall weighted average cost of capital (WACC). Since we use asset betas, however, the WACC usually decreases when we calculate the firms overall WACC. The equity securities held as assets by the pension plan can have an average beta that is higher than the beta of the sponsoring firm’s assets.

However, the weighted average asset beta for the plan, assuming debt securities have zero betas, is usually less than that for the sponsoring firm’s operating assets, so combining the firm’s and plan’s assets usually produces a lower WACC.

Boatman also starts out with a true statement when he says that pension plans usually hold long term bonds to match their pension liabilities.

However, it is the proportion of equity securities in the plans assets that drives the risk of the plan assets, not the proportion of debt (fixed income). The rest of his statements are correct. (Study Session 5, LOS 22.b)