Exam 2 Revision Flashcards
4 problems with Mark2Market
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
How can non-financial risks be allowed for in M2M?
How can financial and non-financial risks be allowed for in discounted cashflow?
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
What are the 4 problems of Discounted Cashflow method?
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?
In the discounted cashflows, how do we discount bonds, how do we discount equities?
Market spot rates for bonds
Discounted dividend model for equities
What is the general name for M2M method?
Replicating portfolio, fair value
What is the fair value alternate of M2M? what’s the weakness?
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
How and why do we adjust the discount rate on corporate bonds, different from that on government bonds
Government bonds is from market spot rate yield curve
Corporate bond needs to be adjusted for higher risk and lower marketability
4 types of share valuation
General DDM
Simplified DDM
EVA for exec compensation
Key factors and market price of equivalent companies
How would you value options like calls
Arb free methods
How would you value swaps
Series of forward contracts
the 3 other yield comparison’s rather than Exp Ret=Req Ret’s
Normal yield
Yield ratios
Technical analysis/index levels
The main influences on bond yields/prices
POISE-IF-I Inflation Interest Exchange rate Institutional cashflow Fiscal deficit Other factors that might effect inflation or interest rates PIA-RRR Supply
What factors influence supply?
Fiscal policy
Tech innovation
If equity market depressed, get finance through bonds
What are the investor preference factors?
LEFT RUM Liabilities Education Fashion Tax regime
Regulation
Uncertainty in politics
Marketing
What factors effect equity markets
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)
Who are the 3 main players in the property market?
Investors
Developers
Occupiers
How does QE work? How does money printing usually work?
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
What are the 4 main risks of QE?
Inflation
Banks not lending out their surplus
Asset bubbles
Investing money in overseas economy
Successful project?
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
What is OFFER?
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
What is REG CUSHION?
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
What is SAFER
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
What is divergence?
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
What are the middle things in REAL WACC?
Gross cost of debt, gross cost of equity
DDM Model Assumptions
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
Factors affecting asset demand
PIA-RRRRRRRRRR Preferences Income Alternatives Risk/Return
Immunisation problems
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
Problems with past data?
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
Calculate liability reasons
IP MAD DOGS Investment strategy Premium setting MandA's Accounts (published and internal) Discretionary beenfits Discontinuance benefits Option terms Gtee costs Statury valn
Sources of suplus
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
Reasons to reinsure?
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
What is integrated risk cover?
ART, reinsurance for multi lines multi years
What is post loss funding?
Contingent capital, bonds convert to equity on specified event, e.g. capital falling below SCR
What’s the CAT bond a type of, when does it pay?
ART, securitised risk, pays coupons, no repayment of principal if event happens
