Chapter 33 - Investment

Question 1

We can consider asset types according to what characteristics

Answer 1

MERCS T

• Marketability
• Expenses
• Return
• Currency
• Security
• Term

Question 2

Characteristics of government fixed-interest bonds

Answer 2

• Nominal return
• Considered the most secure type of asset, other than cash
• Most marketable asset type
• Dealing costs tend to be low
• Term depends on local market, but typical range is from 0 to 15 to 20

Question 3

Characteristics of index-linked bonds

Answer 3

• Coupon payments will be defined with reference to some index or value
• Less marketable than fixed interest government bonds

Question 4

Characteristics of corporate fixed-interest bonds

Answer 4

Return - slightly better than government bonds of equal term
Security - Could be a significant problem, especially if company is not highly rated
Marketability - is often poor, and dealing costs high
Term - similar to those found for government bonds

Question 5

Characteristics of equities

Answer 5

HE DIMPS

• Higher expected returns than government bonds
  over the long term
• Equities can generally be held in perpetuity
• Dealing expenses are linked to marketability
• Income and capital values can be volatile
• Marketability depends on the size of the company
• Provide a long-term real yield as companies grow in line with inflation, dividends tend to grow in line with GDP
• Security depends on profitability of the company

Question 6

Characteristics of property

Answer 6

• Relatively high return
• Seen as a secure investment, although the actual income stream may suffer occasional interruptions
• Very unmarketable, significant dealing expenses
• term is very long term

Question 7

How should a company select investments

Answer 7

It should be selected so that the investments are appropriate to the nature, term, and currency of the liabilities

Question 8

What is the principles of investments

Answer 8

The company should invest so as to maximise the overall return on the assets, subject to the risk being taken on being within the financial resources available to it

Question 9

Why is perfectly matching assets to liabilities not desirable
and
Under what circumstances would perfect matching be desirable?

Answer 9

It eliminates the possibility of making an investment profit

Perfect of nearly perfect matching is desirable if the company has very low free assets such that, without matching, the probability of ruin will be unacceptably high

Question 10

What can the nature of the benefits be subdivided into

Answer 10

• Guaranteed in money terms - this consists of benefit payments where the amount payable is specified in the life insurance contract in money terms
• Guaranteed in terms of an index of prices or similar - this consists of benefits whose amount is directly linked to such an index
• Discretionary - this will consist of the future bonus payments under with-profits contracts, and surrender values where these are not guaranteed
• Investment linked - this will consist of the benefits under the unit-linked and index-linked contracts, the amount of which are determined directly by the value of the investments underlying the contracts

Question 11

What is the discounted mean term of an asset

Answer 11

it is defined as the weighted sum of the terms of the payments, where the weight attributed to each term is the present value of the payment at that term

Question 12

Why might a company want to invest overseas

Answer 12

LED

1. matching Liabilities dominated in a foreign currency
2. higher Expected return:
   - As fair compensation for higher risks involved
   - As a result of exploiting inefficiencies
3. Diversification by:
   - Country
   - Economy
   - Stock market
   - Currency
   - Industry
   - Company

Question 13

7 Theoretical and practical problems with immunisation

Answer 13

MIL DRAFT

• immunisation removes MISMATCHING profits and losses apart from a second-order effect
• the theory relies upon small changes in INTEREST rates
• immunisation is generally aimed at meeting fixed monetary LIABILITIES
• the theory ignores DEALING costs
• in practice, the portfolio must be constantly REBALANCED to maintain:
  – equal discounted mean term
  – greater spread of asset proceeds
• ASSETS of a suitably long discounted mean term may not exist
• the theory assumes a FLAT yield curve and level interest rate changes at all times
• the TIMING of asset proceeds and liability outgo may not be known