Corporate Financial Management Tertiary Sector

Questions: 1.What are the important factors that should be considered by tertiary sector employees when they are deciding whether to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan? What issues relating to the concept of the time value of money may be important in this decision-making process? 2.If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio with a pin. Explain why this is not the case? Answers: 1. Tertiary sector employees are those employees which are involved in providing services i.e. main employment area is of service. There are three types of sector and tertiary sector or service sector; employees are required to make their own superannuation funds as they are not working under any employer. In terms of maintaining superannuation funds for employees, there are two major plans that employee can select for their superannuation contribution and they are defined benefit plan or investment choice plan. There are various factors that shall be considered while selecting superannuation plan between defined benefit plan and investment choice plan. In order to understand different factors, first we need to understand these two plans and then decision of selection of plan will be taken. Defined benefit plan: Under defined benefit plan what amount is required to be received by employee is defined at the initial stage or at the starting of the defined benefit plan. Defined benefit plan is based onrequirement of employee in terms of amount that employee wants to receive at the age of superannuation or at the time of retirement. In defined benefit plan, both employee and employer contribute specified amount of contribution. This contribution is based onemployees earning (salary), age of employee, tenure of service in terms of no of years served by employee in the service or will be serving. Ddefined benefit plan can be used by employers as tool for increment of employees pay or cost to company (Basu, and Drew, 2010). Final salary plan in defined benefit plan is the most common plan for superannuation which calculates pension of employees by using three important variables and they are as follows: Pensionable service i.e. no of years of which pension is required to be paid to employee Pensionable earnings i.e. this is the estimation of salary that employee will be drawing at time of retirement or superannuation Accrual rate i.e. this is the portion of the earning that employee will be receiving at the year end under the selected scheme (Stockton, 2017). Therefore following is the formula of calculating pension income of employee under defined benefit plan: Number of years worked * Salary at the time of retirement or superannuation * Accrual rate It can be analysed that pension fund or funds that employee in tertiary sector will be getting largely depends on salary, no of years of service and accrual rate that employee belongs to (Defined-benefit plan inside a 401(k), 2012). But in this type of superannuation fund, employees are able to set their contribution in the fund and will get pension at the time of superannuation accordingly. Benefits available to employees from the plan can be available at the time of creating this plan. There are some tax incentives also available on this plan therefore this plan can suit tertiary sector employees (Schreiber, 2016). Unfunded defined benefit plan: While selecting defined benefit plan, employees are required to select one plan out of funded defined benefit plan or unfunded defined benefit plan. In case of unfunded defined benefit plan, there is no asset or investment is created for investing in the same. On the other hand, in case of funded defined benefit plan, there is one or two asset or investment created. All contributions of employee and employer shall be invested in that asset or assets (Most and Wadia, 2015). At the time of payment of pension or other retirement benefits i.e. superannuation time, asset or investment created will be sell-off and funds will be transferred to employee. Major drawback of funded defined benefit plan is that; amount that will be received at the time of maturity is not known in advance. Investment choice plan Under investment choice plan of superannuation plan, individual investment account will be opened with the investment company and these investments can range from any amount. In case of investment choice plan, employer contribution and employee contribution and any gain or interest or units earned during the year or period will be invested altogether in the single or multiple investments. In case of investment choice plan, employees have the power or option of changing their investment in any form of option based on some factors. Major advantage of investment choice plan is that employee will be able to manage their superannuation funds. In other words under investment choice plan, employees cam make choice of funds that they want to investment into. Another advantage of investment choice plan is that employee in of tertiary sector can make portfolio of investment or assets that they want to invest in. There are some strategies that employee can adopt for the purpose of using investm ent choice plan. Secured fund, shares fund, trustees selection fund, stable fund and many other finds are some example of investment choice funds. Factors that should be considered by tertiary sector employees for deciding superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan are as follows Risk profile: Major consideration that employees of tertiary sector shall consider is of level of risk that they are willing to take. Both the superannuation funds and contribution is different from each other. Defined benefit plan is less risky as compared to investment choice plan. Defined benefit plan is not linked with market; therefore there is less risk in this plan. On the other hand, investment choice plan there are large no of investments or options there. Some of them can be equity or market linked (Building super on a fair foundation: Reform of the taxation of superannuation contributions, 2012). Therefore risk is the major factor that tertiary sector employees shall consider. Inflation rate: Inflation is the rate at which dearness or cost living increases as the inflation rate increases and vice-versa. In order to take decision related to deciding superannuation contributions shall be considered. In case of defined benefit plan, inflation rate plays very important role as this is long term plan. Under defined benefit plan, investments are for longer period and in this case value of money decreases year by year. Therefore this requires more contribution from employees (Modelling the macroeconomic effects of an increase in superannuation contributions, 2016). Time frame of investment: Time frame of investment plays vital role in selecting superannuation contribution plan. It shall be considered by employee whether he / she wants to invest for the longer period of time or for shorter period. Investment choice plan can provide better results in short term also. But defined benefit plan will only provide higher benefits in long terms and age of employee shall less. Therefore time frame of investment or superannuation funds shall be considered before deciding (Awad, 2009). Financial goals: Financial goal can vary individual to individual. There are some financial consideration that individual considers before deciding the superannuation to invest in. If financial goal of individual or tertiary sector employees is to gain higher profit and ready to take higher level of risk then he / she will select investment choice plan (Ingles and Richardson, , 2010). On the hand, individuals requires moderate level of pension income and at stable rate then tertiary sector employees can select defined benefit plan. Issues relating to the concept of the time value of money Time value of money is the concept which analysis or undertaken the concept of diminishing value of money as the time passes or in future period. Time value of money has the role to play in selecting or deciding superannuation contribution fund. Both defined benefit plan and investment choice plan has different treatment and mitigation procedure in terms of managing time value of money. Time value of money concept is used in the decision making process of deciding superannuation funds. For analysing present value of superannuation contribution and pension amount that will be received after the superannuation or retirement, time value of money concept is used (Brown, Gallery, Gallery and Guest, 2004). Inflation rate prevailing in the market and unpredictable market conditions are some factors that support use of time value of money concept in decision making. In this concept, net present value of the superannuation contributions and pension amount that will be received at superannuation will be calculated. Present value of contributions and amount to be received amount will be adjusted with inflation rate and thus are in real values. Therefore issue of real cash flows (inflow and outflow) of superannuation contribution and desired amount at the time of superannuation has been considered by time value of money concept (Jefferson, 2012). Recommendations: From the above definitions and explanations of defined benefit plan and investment choice plan it can be concluded that investment choice plan is highly customised superannuation plan. In order to provide, maximum flexibility in terms of designing and developing superannuation plan and cash outflows (contributions) and cash inflows (pension amount), investment choice plan shall be recommended. Another reason for selecting investment choice plan is that in defined benefit plan future or superannuation amount is certain i.e. it cannot be increased. But in case of investment choice plan, future plan can be increased according to the requirement or market situation. 2. Efficient market hypothesis Efficient-market hypothesis is the market situation in which price of commodity or stock or asset is the reflection of all available information about the business organisation. In other words, efficient-market hypothesis is the situation under which price of entitys stock or shares have been determined by incorporating all information about the company. Efficient-market hypothesis implies that asset price or stock price is already at fair value i.e. no investor can gain or loss in the stock market (Narayan, Narayan, Popp and Ali, 2015). Efficient-market hypothesis theory or situation has been opposed on the basis that there are various factors that all together made assets price. Therefore in this situation, stock or shares for the purpose of investing can be picked very easily or without applying any skills (Denis, Zoran and Velimir, 2012). In the market situation of efficient-market hypothesis, since there is no consideration of past information, trend analysis, market information , market condition and no other consideration has been put to value stock or asset price. In this situation, price of stock or asset does not move or change because of market changes or conditions. Role of pension fund managers in portfolio management Therefore in this market, role of manager or portfolio manager becomes very easy. It is possible that need of portfolio manager may comes to an end as no consideration is required to be put to any circumstances. Role of fund manager in portfolio management will also get hampered and role and importance of pension fund manager will get diluted (Jovanovic and Schinckus, 2016). As in case of efficient-market hypothesis, there is no consideration of past information and market happenings therefore role of pension fund manager will not be required any more. Pension fund manager, especially in investment choice plan, has to keep updating plan or portfolio of employee. Therefore in the situation of efficient-market hypothesis, no consideration is required. Therefore in this situation, pension fund manager will be able to manage portfolio with ease (Superannuation: How to deduct superannuation contributions by passive investment trusts, 2013). But it can be analysed that, this situation does not exists in the market or will never exists in the market as there are various factors that are to be kept in mind before making investment or select funds for superannuation contribution. Efficient-market hypothesis can never be the case in any form of market, as market forces are very strong and interaction and integration of these forces will impact value of share or asset (superannuation fund or contribution). Along with this, in case of efficient-market hypothesis, it is suggested that no investor will be able to gain higher than other. In this situation, all investors will be gaining same amount of profits therefore there is no question to hire pension fund manager for the portfolio management (Darst and Ebrary, 2013) Therefore, it can be concluded that efficient-market hypothesis is not the case, which can be exist in the market or at investment market because of its vague and unproved basis. References Awad, A. (2009, January 29). Expanding your insurance options with super. Money Management, p. 25. Basu, Drew. (2010). The appropriateness of default investment options in defined contribution plans: Australian evidence. 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