Exam 2 Revision

Question 1

4 problems with Mark2Market

Answer 1

Choice of corporate bonds or govt (corporate lowers the liability value)
No asset matching the duration of the liability, government or corporate
No liquid market for the types of liability e.g. mortality. Consider a series of options
Non-financial risk is not automatically allowed for

Question 1

How can non-financial risks be allowed for in M2M?

How can financial and non-financial risks be allowed for in discounted cashflow?

Answer 1

Increase the liability cashflows manually
Lower discount rate
DCF:
BE+margin for cautiousness in assumptions e.g. % load into mortality assumption
A risky discount rate, like the WACC, reflects risk of the liabilitiy
A contingency loading, find the liability value then add on a certain percentage

Question 2

What are the 4 problems of Discounted Cashflow method?

Answer 2

Couldn’t get away with it in the real world
Market value of assets not equal to discounted value
Doesn’t allow for financial or non-financial risks
How to pick the long term investment return assumption for discounting in first place?

Question 3

In the discounted cashflows, how do we discount bonds, how do we discount equities?

Answer 3

Market spot rates for bonds

Discounted dividend model for equities

Question 4

What is the general name for M2M method?

Answer 4

Replicating portfolio, fair value

Question 5

What is the fair value alternate of M2M? what’s the weakness?

Answer 5

Bond yield plus equity risk premium

Doesn’t take default risk into account, so it lowers the liability pv but doesn’t account for risk

Question 6

How and why do we adjust the discount rate on corporate bonds, different from that on government bonds

Answer 6

Government bonds is from market spot rate yield curve

Corporate bond needs to be adjusted for higher risk and lower marketability

Question 7

4 types of share valuation

Answer 7

General DDM
Simplified DDM
EVA for exec compensation
Key factors and market price of equivalent companies

Question 8

How would you value options like calls

Answer 8

Arb free methods

Question 9

How would you value swaps

Answer 9

Series of forward contracts

Question 10

the 3 other yield comparison’s rather than Exp Ret=Req Ret’s

Answer 10

Normal yield
Yield ratios
Technical analysis/index levels

Question 11

The main influences on bond yields/prices

Answer 11

POISE-IF-I
Inflation
Interest
Exchange rate
Institutional cashflow
Fiscal deficit
Other factors that might effect inflation or interest rates
PIA-RRR
Supply

Question 12

What factors influence supply?

Answer 12

Fiscal policy
Tech innovation
If equity market depressed, get finance through bonds

Question 13

What are the investor preference factors?

Answer 13

LEFT RUM
Liabilities
Education
Fashion
Tax regime

Regulation
Uncertainty in politics
Marketing

Question 14

What factors effect equity markets

Answer 14

SPICIER INFORMER
Inflation, real, actual, expected, uncertainty
Interest, real vs. inflation too
Exchange rate (exporters)
Institutional cashflow
Fiscal deficit
Other factors that might effect inflation or interest rates
PIA-RRR
Corporate growth in profits, dividends
Expected profits
Riskiness versus other assets
Real economy growth
Risk appetite
Market sentiment
Supply
#rights issues/share buy backs/privatisations (supply side)

Question 15

Who are the 3 main players in the property market?

Answer 15

Investors
Developers
Occupiers

Question 16

How does QE work? How does money printing usually work?

Answer 16

Buy assets off commericial banks, thus demand increase and price does, yield decreases
Banks surplus increases thus hopefully allows it more risk
Usually the government buy short term government bonds, to lower sterm interest rates, but if close to 0 it’s useless
QE can also be used to buy long term assets, thuse decreasing long term rates

Question 17

What are the 4 main risks of QE?

Answer 17

Inflation
Banks not lending out their surplus
Asset bubbles
Investing money in overseas economy

Question 18

Successful project?

Answer 18

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

Question 19

What is OFFER?

Answer 19

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

Question 20

What is REG CUSHION?

Answer 20

Reasons to keep capital

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

Question 21

What is SAFER

Answer 21

Reasons to underwrite?
SAFER
Substandard lives are identified and terms changed
Avoid anti-selection
Financial underwriting against overinsurance
Experience in line with expected
Risk classification to set a correct premium for the risk
Reinsurance easier to obtain

Question 22

What is divergence?

Answer 22

Reasons to analyse surplus
DIVERGENCE
Divergence of A vs Expected, find the effect of
Infomration to management and accounts
Variance looking
Experience momitoring 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

Question 23

What are the middle things in REAL WACC?

Answer 23

Gross cost of debt, gross cost of equity

Question 24

DDM Model Assumptions

Answer 24

D, an annual dividend first paid at time 1
i, constant effective annual required rate of return
g, constant effective annual rate of divdiend growth
i>g
i, g both real or both nominal
taxes and expenses ignored
Dividends are reinvested at rate i
Share held in perpetuity

Question 25

Factors affecting asset demand

Answer 25

PIA-RRRRRRRRRR
Preferences
Income
Alternatives
Risk/Return

Question 26

Immunisation problems

Answer 26

Fixed liabilities
Small profits
Flat yield curve
Constant rebalancing
Taxes/dealing costs ignored
Suitable assets may not exist
If timings of cashflows are unknown we can't do it

Question 27

Problems with past data?

Answer 27

BEACHES
Balance of homogeneous groups changed
Experience changes
Abnormal fluctuations
Changes in how data was recorded
Heterogeneity in group we're applying assumptions to
Errors in the data
Statistically random fluctuations

Question 28

Calculate liability reasons

Answer 28

IP MAD DOGS
Investment strategy
Premium setting
MandA's
Accounts (published and internal)
Discretionary beenfits 
Discontinuance benefits
Option terms
Gtee costs
Statury valn

Question 29

Sources of suplus

Answer 29

CAMBODIA
Changes in assumptions/legislation
A reclaculation
Modified conribution rate
Bulk transfer of liabilities
Options taken up
Discretionary benefits
Interest on surplus
Actual not equal to expected
Errors

Question 30

Reasons to reinsure?

Answer 30

SAD LIFE
Smoothing
Avoid large losses
Diversify
Limit exposure to single risks/accumulations
Increase NB capictiy
Financial assistance (NB, solv)
Expertise e.g. data/pricing

Question 31

What is integrated risk cover?

Answer 31

ART, reinsurance for multi lines multi years

Question 32

What is post loss funding?

Answer 32

Contingent capital, bonds convert to equity on specified event, e.g. capital falling below SCR

Question 33

What’s the CAT bond a type of, when does it pay?

Answer 33

ART, securitised risk, pays coupons, no repayment of principal if event happens