Question 6.19 (ii) of the Q&A bank ask you to outline suitable matching assets that might be held by the following scheme:
DB pension scheme which offers benefits linked to final salary. Pensions in payment are guaranteed to increase at the lower of price inflation or 5% each year.
The memo says that conventional bonds may be a good match for current pensioners' benefits (if inflation is greater than 5% p.a.)
The one reason I could see for this is that investors will demand a real yield and hence if inflation is above 5%, then investors will demand yields to be greater than 5% as well.
So why is this strategy only appropriate when inflation is greater than 5%? Suppose that inflation is 4%, then investors would demand at least 4% and the liability outgo can still be met?