• We are pleased to announce that the winner of our Feedback Prize Draw for the Winter 2024-25 session and winning £150 of gift vouchers is Zhao Liang Tay. Congratulations to Zhao Liang. If you fancy winning £150 worth of gift vouchers (from a major UK store) for the Summer 2025 exam sitting for just a few minutes of your time throughout the session, please see our website at https://www.acted.co.uk/further-info.html?pat=feedback#feedback-prize for more information on how you can make sure your name is included in the draw at the end of the session.
  • Please be advised that the SP1, SP5 and SP7 X1 deadline is the 14th July and not the 17th June as first stated. Please accept out apologies for any confusion caused.

Sept 2014 - Question 6 (iii)

O

omurice

Active Member
Hi,

On question 6 about calculating the investment income if the fund had been invested in the index, the answers shown are to use the market value of fund at each initial period multiplying by the growth in the capital return index and the quarterly dividend yield. ASET explains that this is assuming investment income is payable at end of period. Why is this so? I thought calculating this way would assume that the income is paid throughout the quarter.

ASET also shows another formula that assumes the income being payable throughout the quarter by taking the end fund value subtracting external cashflows. I dont really understand this approach as why are we using the pension fund's end fund value? Doesnt this assume that we will use the fund's capital growth instead of the index's capital growth?

Thanks a lot in advance!
 
In this case, we were not sure why the examiners did not accept the alternative formula, as they both seemed fine to us. The first thing is that you should always multiply a dividend yield by a fund value at the same date. So, (dealing with Q2) since the 4.2% yield is as at the end of the quarter, we need to multiply by a fund value as at the end of the quarter. We have assumed that the external cashflows (30 in this case) occurs at the end of the quarter, so the two ways to get a reasonable fund value at the end of the quarter would seem to be:
4050 - 30
or
3600 *(1776/1603)
The examiners preferred the second in this case.
The difference is that the first takes the final fund value, which would include all of the investment income received in the period (60 in this case), and deduct the external cashflow that occurred on the last day. The second takes the value at the start of the period and applies the benchmark returns to estimate the value at the end when the dividend yield was taken. The first method may theoretically slightly overestimate because the fund value used includes the investment income, which may not have been available for the whole of the quarter. The second ignores the investment income in the period, which may oddly underestimate the result because investment income would have been received, and would have been reinvested, and therefore would have earned a little bit of investment income.

In most such questions we have witnessed the examiners awarding marks for most reasonable approaches.

I hope this helps.
 
I see, thank you so much for your reply!

I was just confused because correct me if I'm wrong, setting investment income aside, these two approaches also assumes two different capital growths for the funds. The first approach (4050-30) seems like it will be invested in the pension fund (while getting investment income from pension fund throughout the quarter) and will then only invest the final fund value into the index at the end of the quarter just only to get the dividend from the index.
 
Yes, I suppose it does. If you use the final value you are exposing the fund to its actual performance during the period. If you use the start then its getting the benchmark performance. If these are different by a large margin then it will impact the result. Both methodologies are perfectly justifiable.
 
You must log in or register to reply here.
Back
Top