3. For the pension plan of a company XYZ, the strategic asset allocation is 60% in global equity and 35% in global fixed income and 5% in US cash.

a. If the global equity market generates negative return and bond yield declines in the coming year, what will happen to the PBO funded ratio? Why? Monthly Volatility Correlation US equity Euro equity US equity 5.0% US equity 1 0.5 Euro equity 4.0% Euro equity 0.5 1

b. The pension plan sponsor of company XYZ wants to reduce the risk of the portfolio. His suggestion is to increase the cash allocation from 5% to 20% since cash is the risk-free asset. Considering cash as an asset and as an investment in a pension portfolio, do you agree with his suggestion? Why?

c. The pension plan sponsor expects the asset return to be low and bond yield remains low in the future. Suppose the pension plan has a PBO funded ratio of 85% currently. In order to minimize the amount of corporate contribution to the pension plan and increase funded ratio, the pension plan sponsor is very interested in applying the Alpha Beta framework to his pension fund. Please provide your recommendation using Alpha/Beta investment framework. What should be the new asset allocation strategy? How much active risk should the pension plan take? Be specific and provide the rationale for your recommendation.

d. In particular, the pension plan sponsor is considering investing in hedge fund. Do you think hedge fund is a good investment vehicle for the pension plan? Give a detailed discussion of hedge funds as an investment in pension plans. Be thorough in your answers.