Chapter 18: Actuarial techniques (1)

Question 1

Uses of Asset pricing models (2)

Answer 1

1. to determine whether an observed asset price is “wrong” - whether an asset is mispriced (and represents a trading opportunity for the shrewd investor)
2. to determine what the price of an asset should be (where it cannot be observed)

Question 2

Absolute pricing ( + example)

Answer 2

absolute pricing prices assets by reference to exposure to fundamental sources of macroeconomic risk, e.g. consumption-based models and general equilibrium models such as CAPM

Question 3

Relative pricing (+ example)

Answer 3

relative pricing considers the value of an asset given the price of some other assets, e.g. Black-Scholes option pricing and arbitrage pricing theory.

Question 4

Use of ALM (Actuaries)

Answer 4

actuaries use ALM to project the assets and liabilities (and related characteristics such as solvency levels) over periods of several years and thereby to review investment policy.

Question 5

Main stages of ALM (7)

Answer 5

1. clarify the key objective of the investment and funding policy.
2. agree suitable assumptions to use in the study
3. collect the data to be used to carry out the projections
4. consider the overall nature of liabilities
5. analyse how the scheme might progress in the future if different investment strategies were adopted
6. analyse different asset mixes in more detail
7. summaries and present the results

Question 6

Asset liability mismatch reserving (2 steps)

Answer 6

1. Asset liability mismatching reserving involves projecting the emerging asset and liability position under a range of possible conditions in order to establish the extent to which assets and liabilities are mismatched.
2. Appropriate supplementary reserves can then be set up to cover the possible levels of shortfall identified.

Question 7

ALM (in banking):

Answer 7

In banking, ALM is used to ensure that any mismatches between assets and liabilities are not so large as to expose the bank to serious risk if there is a sudden sharp market movement in the near future.

Question 8

ALM (Institutional investors)

Answer 8

ALM is commonly used by institutional investors when setting their investment strategy.

Question 9

Resilience testing

Answer 9

Resilience testing considers the impact of an immediate change in market conditions.