Cashflow Models

Question 1

Describe the characteristics of an interest-only loan

Answer 1

The loan is repayable by a series of interest payments during the term of the loan

followed by repayment of the full capital amount at the end of the term

amount of capital outstanding therefore remain fixed over the term of the loan

if interest rates is fixed, the interest payments will be known in advance and if the interest rate is variable, the interest payments will be unknown at the onset

Question 2

Describe the characteristics of a repayment loan

Answer 2

Loan is repayable by a series of payments, each of **which include partial repayment of the loan capital and additional interest amount. **

amount of capital therefore reduces over time.

if the interest rate is fixed, so will the repayments

if the interest rates vary, so will the repayments

Question 3

Similarities between an annuity certain and contingent annuity

Answer 3

provide a regular series of payments in return for a single premium (lump sum) paid at the outset.

frequency of payment will be specified as well as the payment amount

Question 4

Difference between annuity certain and contingent annuity

Answer 4

AC = Number of payments is fixed in advance

CA = payments are dependent upon certain events usually the survival of the policyholder hence the number of payments made will not be known in advance

Question 5

Discuss in detail the amounts and timing of the cashflows of an index-linked bond from
the perspective of the issuer

Answer 5

-Initial positive lump sum inflow
* Certain amount and timing.
* A series of regular outflows of coupon payments until redemption. These may be payable
more frequently than annually but are at regularly spaced intervals.
* Coupons linked to an inflation index that is sometimes lagged, e.g. linked to an inflation
index with a 3-month time lag.
* Due to unknown inflation rates, coupons are uncertain in amount.
* The coupons are certain in timing (the issuer knows when payments are made and is not exposed to default risk as they hold the principal)
* The redemption payment is also linked to an inflation index and may be at, below or above par. The amount is uncertain due to inflation.
* Timing of redemption payment is certain unless the bond is redeemable at the option of the investor.

Question 6

Pure endowment

Answer 6

insurance policy which provides a lump sum benefit on survivial to the end of a specified term usually in return for a series of regular premiums

A large cashflow happens at thend end of them, only if the policyholder has survived. If the policy holder dies before the end of the term, there is no positive cashflow

Question 7

Endowment

Answer 7

providers survival benefit at the end of the term but also provides a lump sum benefit on death before end of the term. Benefits are provided in return for a series of regular premiums

Question 7

Term assurance

Answer 7

insurance policy which provides a lump sum benefit on death before the end of a specified term in return for a series of regular premuim

if policholder survives to the end of term, there is no positive cashflow

Question 8

contigent annuity

Answer 8

similiar contract to annuity certain but the payments are contigent upon certain events such as survival hence the payment term for the regular cashflow is uncertain

Question 9

Provide 3 examples of contigent annuities

Answer 9

single life annuity- regular payments are made to the beneficiary are dependent on the survival of the beneficiary

joint life - covers 2 lives, regular payments are dependent on the survivial of one or both of those lives

reversionary - based on 2 lives, regular payments start on the death of the first life if and only if the second life is alive at the time. Payments then continue until the death of the second life. known as spouse’s pension and dependent ‘s pension

Question 10

Car insurance policy

Answer 10

short term contract
in return for premium (lump sum or paid monthly) , insurer will pay for damages or theft to the vehicle (property cover), in some countries insurer will pay for third party death, injury or damage to the third party property this is known as property cover

Question 11

Health cash plan

Answer 11

short term
in return for a premium, the policyholder is entitled to the benefits which may include hospital treatment paid for in full or partial , cash benefits in place of treatment such as fixed sum per day spent in hospital as an in patient