Explain the risks associated with Pension Funds. How can the performance of these funds be measured? Discuss.
From an investor's point of view, pension risk is the risk to a company's EPS and a financial condition that arises from an underfunded defined-benefit pension plan. Before we define "underfunded," it is important we note that pension risk arises only with defined-benefit plans.
A defined-benefit pension plan promises to pay a specific (defined) benefit to retired employees. In order to meet this obligation, the company must invest wisely, so that it has the funds to pay the promised benefits. The company bears the investment risk, because it has promised to pay employees a fixed benefit and must make up for any investment losses.
Under a defined contribution plan, which is sometimes called
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