Texas A&M UniversityFINC MISCFinal_Assessment_6_Template

[FAP Final Assessment] Instructions: You must enter your answers to each assessment question in the sections noted below, and must not change any information contained within the first set of black brackets [] for eac ...

[FAP Final Assessment] Instructions: You must enter your answers to each assessment question in the sections noted below, and must not change any information contained within the first set of black brackets [] for each Task. [ Task 1 ] ksat Memorandum To: Project Lead From; FAP Candidate Re: Risk Management Policies Supporting the CDEF This memorandum is intended to provide the CDEF management team with a list of risks that the fund faces along with recommended risk mitigation strategies for the most important of those risks. The following risk categorization and definition tool (RCD) identifies multiple risk relevant to the management of the education fund in the four major categories of risks: Financial, Strategic, Insurance, and Operational. Risk Category Risk Definition Likelihoo d Severity Financial Market Return The risk that market returns differ from expectations, resulting in insufficiency or excessive surplus in fund balance Medium High Inflation Rate of Tuition The risk that inflation rate differs from expectation, resulting in liabilities (future tuition payments) being higher or lower than expected Medium High Unemployment The risk that unemployment rates increase or decrease due to economic downturn or other reasons, resulting in fund contributions being higher or lower than expected Medium Low Credit Default When investing in bonds, there is a risk that some bond issuers default on their obligations to the fund Low Medium Interest Rate Fluctuation in interest rates impacts the price and value of treasury bills Medium Low Strategic Regulatory/Politica l Risk that future legislation does not support the CDEF’s goals, such as a legislated reduction in tax payments or a re-appropriation of funds (unlikely given that the fund was set up separate from other government funds) Low Medium Reputational Damage Risk that stakeholders form an unfavorable view of the fund for any Low Low FA – page 1reason, including political atmosphere or errors Capital Availability Risk that the investment portfolio is not sufficiently liquid to cover financial obligations on any given business day Low High Social/Cultural Trends Risk that citizens of Cascadia favor college educations less in the future, opting for apprenticeships or other ways to enter to workforce sooner Low Medium Insurance Beneficiary Behavior Risk that the number of beneficiaries differs from expectation due to implementation of CDEF. i.e. attrition rates do not fully capture the new incentive to get a college education High Medium Contributor Behavior Risk that employed population size assumption does not reflect behavior change due to new tax (e.g. emigration) Low High Operational Litigation Risk that litigation costs (e.g. lawsuits over program eligibility or fund mismanagement) affect fund management expenses Low Medium Reporting Risk Risk that material errors in investment statements increase internal cost due to re-work and external cost due to fines or settlements Low Low Loss of Key Personnel Risk that key personnel leave the fund, resulting in an interruption to operations Low Low Among the risks in the RCD, key risks are defined as any risk for which the likelihood OR severity is high, or any risks in which both likelihood AND severity are medium. The risks that meet these criteria are Market Return, Inflation Rate, Capital Availability, and Beneficiary Behavior. Market return is considered a key risk due to the volatility of equity markets and the impact of returns deviating from expectation on CDEF’s assets. This risk includes both sets of key stakeholders: contributors and beneficiaries. Lower market returns could result in underfunded tuition liabilities, while higher market returns could result in taxpayers contributing more than necessary to maintain the fund. I recommend a diverse investment portfolio consisting assets with uncorrelated or inversely correlated rates of return to reduce this volatility. No more than 50% of the portfolio should be placed in a single asset class. This strategy would reduce the impact of large positive or negative moves in a single asset class. Inflation is considered a key risk to the liability cash flows, specifically as it applies to the tuition rate. When compounded across the entire 33-year projection period, a small change in annual tuition inflation can result in a large surplus or deficit for the fund. Tuition inflation impact can be partially hedged by holding assets whose value typically rise with inflation. Examples of such assets include commodities, real estate, and gold. Capital Availability ties to one of CDEF’s main objectives, which is to “Ensure the CDEF meets its financial obligations on any given business day.” Failure to do so would result in reputational damage, possible fines, and potential for adverse financial results from selling assets before maturity. To mitigate this risk, I recommend that the CDEF maintain a minimum of 40% of investments in stable, liquid asset classes, such as treasury bills. Preliminary modeling indicates that tuition payments could be over 25% of accumulated fund balance in the early years of the fund assuming 0% return on the