If a defined benefit pension plan has liabilitiesthat are interest-rate sensitive and the plan sponsorallows investment in a portfolio of commonstocks, can you determine what will happen to itsfunding gap if interest rates change?
What will be an ideal response?
The stock market is generally influenced like bonds and other fixed-income securities when interest rates change. That is, stock values fall when interest rates increase and values rise when rates fall. However, there is much more volatility for common stocks than for fixed-income securities. Although it would involve some difficulty to predict any precise relationship between common stock and the institution's funding gap if interest rates change, generally one can say that assets would be more volatile relative to liabilities. In conclusion, if interest rates went down then assets would go up more than liabilities giving having a positive effect by decreasing the funding gap; the opposite would occur if rates went up.
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