CFA Practice Question

There are 334 practice questions for this study session.

CFA Practice Question

A lower discount rate ______ service cost and ______ interest cost.
A. increases, decreases.
B. increases, increases.
C. decreases, decreases.
Explanation: A lower discount rate increases both service cost and interest cost, and thus increases reported pension cost.

User Contributed Comments 5

User Comment
danlan2 In later stage, a lower discount rate may decrease reported pension cost.
volkovv Even though B is most appropriate statement here. But lower discount rate may also indirectly increase interest cost. Lower discount rate produces higher PBO and then that discount rate is applied to beginning of the period PBO to calculate interest cost, so even though the discount rate may be lower, PBO may be significantly higher and together that will result in higher interest cost.
Example: discount rate = 7%; Beginning PBO = 10,000; inetrest cost = 10,000 * .7 = 700
Now suppose new discount rate = 6%; depending on acturarial assumptions of years of service, etc. this lower discount rate (which increases PBO) may yiled new PBO = 12,000; new interest cost = 12,000 * .06 = 720. Buttom line, the effect of discount rate is not 100% certain increase/decrease in interest cost.
Queens41 From page 97, reading 23:

"Typically, an increase in the assumed discount rate will decrease the interest component of a company's periodic benefit-related expenses..."
LoCo83 (Sorry for the caps... limited formatting allowed here)

After clicking "Check LOS" on the right hand side menu... under the "Importance of Assumptions" section, it states

'... the net result of INCREASING the discount rate is an INCREASE in the interest cost.'

Suffice to say, one might assume the opposite is also true, that a DECREASE in the discount rate leads to a net result of DECREASING the interest cost, no?

Queens41- I was thinking that decreasing the interest COMPONENT of the company's periodic benefit related expenses doesn't necessarily mean that the interest cost itself increases, it just increases in proportion of the whole expense.

Still confused...
maxsouto Interest cost=PBO from last year*discount rate? am I wrong?
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