Chapter 16 - Asset-Liability management Flashcards
What are some of the main considerations when deciding how to match assets and liabilities? (6)
Is matching necessary and to what degree
Regulation
Trade-off between matching and maximising
investment returns
How practical will it be to match assets to liabilities
Optimal matched position
Level of free assets required when deciding not to match.
What is the optimal matched position?
Matched position which satisfies the provider’s required degree of certainty in meeting their liabilities for the lowest cost, while accounting for regulation and investment objectives.
What are free assets?
Additional capital which is held to cover the possibility that there are insufficient assets to meet the liabilities when they fall due.
What are the principles of investment?
1) Should select investments which are appropriate to the:
Nature
Term
Currency
Uncertainty
of the liabilities, as well as the risk appetite of the provider.
2) Subject to this, investments should be selected to maximise the overall return on assets, comprising of income and capital returns.
When asked to describe cashflows in an exam, what are the important points to consider?
From who's perspective are you examining the cashflows What are the main cashflows Characteristics of the cashflow such as: Positive or negative (Income or outgo) Fixed or real Certain or uncertain amount Certain or uncertain timing and term Structure of the cashflow, e.g. lump sum or regular payments
Net liability outgo = ? (for an insurer)
Benefit pmts + expense outgo - premium/contribution income
What are four different types of liability outgo which have differing degrees of certainty for the provider?
Guaranteed nominal
Guaranteed in terms of an index
Discretionary
Investment-linked
Go through pp.10-12 to see considerations when matching assets to the nature of the liabilities.
.
Read through pp.13-15 for considerations to be made when using free assets for mismatching purposes, depending on the nature of the liabilities.
.
What are the main types of regulatory controls to be expected when using a mismatched asset strategy?
Restrictions on types of assets which can be invested in
Restrictions on the amount of a type of asset which can be used for demonstrating solvency
Restrictions on maximum exposure to a single counterparty
A requirement to match the currency
Requirement to hold a proportion of total assets in a particular class
Requirement to hold a mismatching reserve
Custodianship of assets
Limit to the extent which mismatching is allowed
What is pure matching? Mention some practical issues with this type of matching
Structuring the flow of income and maturity proceeds from assets to precisely coincide with the net outgo from the liabilities under all circumstances.
Many pure matching strategies would require risk free zero-coupon bonds.
Relative price of bonds chosen may be inappropriate.
Term and size of liabilities may make matching unattainable due to unavailability of assets.
What is liability hedging/approximate matching?
Assets are chosen in such a way as to perform in a similar way to the liabilities.
This involves trying to find the best matched position, given constraints on available assets.
What is immunisation, in terms of liability hedging?
Investing assets in such a way the PV of assets - PV of liabilities is robust to a small change in the interest rate (i.e. it will remain positive).
What is duration?
Weighted-average time to payments, where the weights are the present values of each payment. (Can see it as first derivative of payments in terms of time * -v/PV of payments) - see p.19
What is convexity?
Volatility of cashflows to a change in the interest rate. See p.19 (take note of relationship with duration in the case of an annual coupon bond)