TEST 1 Flashcards
(38 cards)
Types of Assets
Fixed Income, Derivatives, Stocks, Real estate, Currency, Commodities, Credit Spreads
1) Asset Liability Management and its Importance
- The coordination of asset portfolios based on the needs of future liability cashflows
- Important because changes in interest rate can have a dramatic effect on the values of assets and liabilities
2) Why might an insurance company be called “very leveraged”?
With the use of segregated funds, they can make a return that is very large with respect to how little they put in to setting up the fund.
3) Identify and briefly describe all the risks an insurance company might face.
IR-the change in the value of assets and liabilities when interest rates change. Market-changes in market values ie inflation, IR, currency, stock values. Credit-default or reduction in credit worthiness of the company. Prepayment-borrower repays before the normal maturity. Liquidity-inability to quickly sell investment or large bid-ask spread. Liab-premiums/claims differ from projections. Other-
4) How can interest rate risk be managed?
IR risk can be managed by matching characteristics of assets and liabilities like duration, convexity, and cashflows amounts and timings.
5) Define market risk.
Potential for losses due to change in market values including changes in interest rate, equity markets, currency exchange rates, inflation NON-DIVERSIFIABLE
6) Define credit risk.
Risk of loss due to default or reduction in credit worthiness of the company (ie downgrade by credit rating agency)
8 Types of Fixed Income assets:
Federal gov, agency, CMHC, provincial, municipal, corporate, private placement, mortgages
Mortgage backed securities
mortgages packed up and traded on financial markets
Private Placement Bonds
Not publicly registered, the borrower goes to insuance companies or others and sells these bonds. EX the Disraeli Freeway Renovations
CMHC
Canadian Mortgage and Housing Corp
Bond examples: Provincial, Municipal, corporate
Manitoba Hydro, City of Winnipeg, Bell Canada
Mortgages 2 types
Commercial and residential
Leverage Example
TD Building 2005-2014
- borrowed 70 mil paid 30 mil
- kept for 9 years and sold for 250 mil
- 150% return
- but only actually put in 30 mil so 250-70=180 which is 500% return
7) 2 examples of liquidity risk
- Inability to quickly sell an investment
- Large bid-ask spread
8) 2 Examples of the largest asset classes held by life insurance companies
Fixed income and Stocks (others - derivatives, real estate…)
9) What is the main difference between corporate and private bonds?
Private bonds are not publicly registered and are issued by the borrower going around to selected companies and offering an investment opportunity, for example the Disraeli Freeway renovation project. Corporate bonds are traded on a public market.
10) What significant features set a mortgage apart from a corporate bond?
The main feature that sets these two apart is that mortgages hold the property as collateral and can repossess it if the loan is defaulted. If a corporate bond defaults, the lender is left to fight over the remains of the companies assets in order to recover their investment.
11) Describe a futures contract.
An agreement to buy or sell a commodity or financial instrument at a predetermined price in the future. Futures are traded on an exchange, have standardized features. With futures you are required to put up an initial margin which allows you to get the financial results of a larger value, meaning there is leverage.
12) Give an example of the leverage inherent in a futures contract.
Futures contracts require a margin to be paid upfront that is usually between 2% and 10% of the contract value. This requirement is put into place so that when there is a change in the future’s value, that amount can be taken directly from the margin without risk of non-payment. For example, if there is a futures contract on coffee, the initial margin for a $10,000 contract may be $500.
13) What two features set a futures and a forward contract part?
Traded on an exchange and standardized vs. private transactions usually with a bank and customizable
14) What are the two definitions of duration that we looked at?
1-average timing of payments
2-indicator of the sensitivity of cash flow’s present values to changes in interest rate
15) Describe two important limitations of duration.
Only effective at mitigating small and parallel shifts in interest rates! in reality, interest rates generally twist and can often change too much for matching duration to limit the risk.
16) Describe the pattern of cash flows for a group of typical life insurance liabilities and draw a picture of what they look like.
-gradual downward slope past 0, hits a min, raises a bit, evens off negative, one last spike down for all the later payments.
