Chapter 33 - Investment Flashcards
Can consider asset types according to the following characteristics: (6)
- Return
- Security (and volatility of market value)
- Marketability
- Expenses
- Term
- Currency
What is an assets running yield?
=(Annual income on investment)/(current market value)
State the principle of investments:
A. In order to minimise risk, a company should select investments that are appropriate to the nature, term and currency of the liabilities;
B. The investment should also be selected so as to maximise the overall return on the assets, where the overall return includes both investment income and capital gains; and,
C. The extent to which the appropriate investments referred to above may be departed from in order to maximise the overall return will depend, inter alia, on the extent of the company’s free assets.
Liability outgo may be split into four categories:
- guaranteed in money terms
- guaranteed ito prices index or similar
- discretionary
- index linked
Limitations of immunisation theory: (7)
- It immunises against profits as well as losses
- Can be difficult to immunise against real liabilities
- Only works with small interest rate fluctuations, though in practice ot is actually usually quite robust to large interest rate changes
- It assumes when the interest rate change, the same change occurs at all terms (assumes a flat yield curve)
- Would need to reanalyse the situation everyday and change investments accordingly
- Assets of the required term may not exist
- Timing of asset priceeds might not be known , and that of liabilities can only be estimated
Decision on assets for discretionary benefits, and whether this will affect the investment approach for guaranteed benefits, will depend on: (5)
- Bonus philosophy of the company (of they give low guaranteed benefits and concentrates on terminal bonus or a significant terminal dividend may tend towards investing primarily in equities, only worrying about matching as policy maturity approaches)
- Level of free assets
- Risk appetite of the company
- Published investment strategy of the company (PRE)
- Views of the company at any time as to the relative performance of the asset class concerned
7 steps to develop an appropriate investment strategy:
- Split liabilities into one if the 4 categories
- Start with investment linked liabilities, match these exactly. Invest in the assets underlying the benefit determination formula
- If possible, match liabilities guaranteed with reference to an index, if not possible then choose the nearest thing
- Match liabilites guaranteed in money terms woth government bonds (and possibly some corporate bonds) of suitable term
- This leaves discretionary liabilities. Ideal would be to invest in equities and properties. Normally heavily weighted towards equities
- Having taken care of all liabilities, how to invest free assets? Normally equities or property. Can take a riskier stance as in step 5
- Modify above strategy to include sufficient cash for company tonoperate on a daily basis without needing to realise any non-cash assets
2 approaches to project investment return on assets:
- Deterministic, point estimate of future investment returns (could be amde to vary deterministically in different years of projection)
- Stochastically, by treating investment returns as random variables
For stochastic asset liability modelling we need to: (10)
- Model future behaviour of assets
- Model behaviour of liabilities, including deciding on any links between asset behaviour and liability valuation (must be dynamic)
- Include the effect of consistent expense inflation
- Specify solvency measure
- Specify acceptable probability of ruin
- Decide upon allowance for new business
- Decide on a period of projection
- Decide on the number of simulations
- Investigate different investment strategies
- Interpret the results
