CHP 21 Flashcards
Other influences on investment markets
- Demand factors
- Investors’ incomes
Amount of money available for investment by institutional investors can have a major impact on market prices.
This is very true for changes in flows of funds into institutions with tightly specified investment objectives. The good returns that will result because of the increase in demand might then set off a spiral of growth.
The reverse of this can also happen.
Other influences on investment markets
- Demand factors
- Investors’ preferences
This can alter by:
• Change in liabilities
• Change in regulatory or tax regimes
• Uncertainty in the political climate
• “fashion” or sentiment altering – sometimes for no reason
• Marketing
• Investor education undertaken by suppliers of a certain asset class.
Other influences on investment markets
- Demand factors
- The price of alternative investments
All investment assets can be viewed to a certain extent as substitute goods. Thus there is a strong correlation between prices of different asset classes.
Other influences on investment markets
1. Demand factors
Demand for an asset will change in one of two main circumstances:
• Investors’ opinion remains the same but external factors alter the demand for that asset. E.g. investor’s income and preference, price of other assets
• Investors’ perceptions of the characteristics of that asset change, principally risk and expected return.
Other influences on investment markets
- Supply factors
- Equity markets
Increase in supply (lost of new shares issued) will put downward pressure on prices.
Other influences on investment markets
- Supply factors
- Bond markets
In government bond markets the supply is largely controlled by the fiscal deficit and its strategy for financing the deficit.
Other influences on investment markets
- Supply factors
- Other investment markets
Sometimes supply in increased by technological innovation.
E.g. derivative markets where better understanding of pricing and reserving for complex products have allowed investment banks to supply then to end users more cheaply, thus increasing the quantity demanded.
Risk mitigation techniques
FAT SIR Further research Avoid Transfer Share Insure Reduce
Identification of sources of risks?
PNE FC PB
Political (government change, 3rd parties)
Natural (storm, earthquake)
Economic (interest rate, currency movement)
Financial (financing problems, costs too high)
Crime (fraud)
Project (poor design, runs behind time)
Business (competition, loss of key personnel, insolvency of contractor)
Risk identification tools
DR RUB Desktop analysis Risk analysis Risk register Upside as well as downside risks identified Brainstorming
Contents of written strategy document
PROSE
Policies (financial, legal, tech, risk management, communications, IT)
Roles and responsibilities of sponsor and 3rd parties
Objectives identification, how to measure, quality standards and financial
Schedule of milestones and key points
Expected cost including insurance
Criteria assessed in initial appraisal
SPURS Synergies with other projects Political constraints Upside potential Results (financial) Scare resources
Characteristics of well run projects
PROJECT CRAMPS Planning (full) Risk analysis is thorough Objectives are clear and meet customer needs Judge (monitor) development Excellent communications Conflict management Thorough testing
Critical path analysis
Relationships with suppliers challenging and stable
Appropriate pace so right things are done on time
Milestone review schedule
Performance and quality standards are set and measured
Supportive environment
Expenses incurred by a product provider?
RAPID COST Renewal admin Asset management Profits Initial admin e.g. put on computer system Design of contract costs Commission Overheads Sales/advertising Terminal (benefits payouts)
Contract design factors?
Ample Direct Factors Admin systems Marketability Profitability Level and form of benefits Early leaver benefits Discretionary benefits Interests and needs of customers Risk appetite Expenses vs charges Competition Terms and conditions of contract Financing (capital requirements) Accounting implications Consistency with other products Timing of contribution to premiums Options and Gtees Regulatory requirements Subsidies (cross)
Evaluation of risk mitigation options
OFFER Overall impact on distribution of NPV's Feasibility/cost Further mitigation required if secondary risks Effect on frequency/severity/correlation Resulting secondary risks
Contents of an investment submission
FIRM PEN Financial results Identification and analysis of key residual risks Recommendation Mitigation strategy Proposed method of financing Effect on investors Non-monetary issues like politics, environment
Considerations beyond investment submission
LAND HO Last minute considerations Allowance for approximations and bias Knowledge not in possession of those who prepared submission Doubts over feasibility Hunch Overall credibility
Factors effecting investment strategy
SOUNDER TRACTORS Size of assets (abs/rel) Objectives Uncertainty of liabilites Nature of liablities Diversification Existing portfolio Returns expected in the long term Tax treatment of assets, investor Restrictions (stat/legal/voluntary) Acrrual of liabilities in future Currency of existing liabs Term of liabs Other funds strategies (competitors) Risk appetite Solvency requirements
Regulatory influences on assets held
TECH SCAM Types of assets restricted Extent of mismatching Currency mismatching allowed? Holder certain assets eg bonds Single counterparty exposure Custodianshup of assets Amount of any one asset restricted for solvency demonstration Mismatch reserve
Ways to values assets
SHAM FADS Smoothed market val Historic book val Adjusted book val MV Fair val Arb val Disc cf Stoch models
Information to be disclosed from benefit scheme
DISCLOSURE Directors pensions costs Inv strategy and perf Surplus/deficit in last year Calculation methods and assumptions Liabilities accruing Options and gtees Sponsors and members contribution obligations Uncertainties (risks) Rights on wind up Expense charges and entitlement to benefits
When does information from benefit scheme need to be disclosed?
PRICE Payment commencement Request Intervals Combination Entry
Reasons why disclosure is important
SIMMERS Sponsor becomes aware of financial significance of benefits Informed decisions can be made Mis-selling avoided Manages expectations of members Encourages individuals to make own provision Regulatory requirement Security of scheme improved
Reasons to analyse surplus
DIVERGENCE
Divergence of A vs Expected, find the effect of
Information to management and accounts
Variance looking
Experience monitoring into ACC
Reconcile values for successive years
Group intone off and recurring sources of surplus
Executive remunerations schemes gives data for it
NB strain effects
Check our assumptions are ok
Extra check on valuation data and process
Reasons to use ART
DESCARTES
Diversification Exploit risk as opportunity Solvency improves Cheaper than reins Availability more than reins Results smoothing Tax advantages Efficient risk management Security improved
Reasons to underwrite
SAFER
Substandard lives are identified and terms changed
Avoid anti-selection
Financial underwriting against over insurance
Experience in line with expected
Risk classification to set a correct premium for the risk
Reinsurance easier to obtain
Why do financial providers need capital?
REG CUSHION
Regulatory requirement for solvency Expenses of NB/new ops Guarantees and options Cashflow timing Unexpected events e.g. fines, actual experience Smooth profit and balance sheet Help demonstrate financial strength to attract NB and to SandP Investment freedom for some mismatching Objectives and opportunity exploitation NB strain financing
Requirements of a good model
VARIABLEE CRISPS CARD
Valid Adequate documentation Rigorous Input parameter values are appropriate Arb free Behavior is consistent Length of run not too long Expenses not too high Easy to understand
Communicable code and output
Reflects risk profile of contracts modeled
Independent verification of output
Sensible joint behaviors of variables
Parameters allow for all significant features
Simple but retain key features
Clear results
A range of implementation methods
Refineable
Developable
