Preface, ACC, Financial Markets Flashcards
What is the actuarial control cycle
The Actuarial Control Cycle is a schematic approach based on a scientific approach to problem solving. Involves a feedback loop and the three stages:
Specifying the problem
Developing a solution
Monitoring the Experience
Why are feedback loops important in actuarial work
Things in the context and environment change all the time and previous assumptions can become invalid. Revision is needed to refine or analyze your work.
The Actuarial Control Cycle must of course be considered in the context of the business, economic and commercial environment (e.g. legislation, taxation, business ethics).
Explain specifying the problem as a part of the actuarial control cycle
Analyse the Risk
Assess Client’s Situation - Focus is on recognising, measuring, analysing and managing risks for your client.
Consider high-level options - Impact of risks and each potential solution on all stakeholders to be considered
Strategic courses of action are debated
Explain Developing a solution as a part of the actuarial control cycle
Selection or construction of a model occurs, parameters are chosen and discuss assumptions
Calculate and interpret results- implications for all stakeholders
Determine solution proposed and main alternatives identified
Formal proposal/report
What’s a dynamic strategy
Dynamic strategy is Contingent on happenings within the market. We will mostly consider static strategies this term
Explain alpha risk
Alpha risk is when you think a fund manager outperforms the fund index. You think you’re picking a good manager to do better than the market and you take on alpha risk
Explain monitoring the experience as a part of the actuarial control cycle
Compare with models previous
Review model - update with current experience
Give feedback into the problem specification
Review business context, update assumptions and identify causes of changes, are they likely to stick
Identify scope for improvement
Analyse the actual vs expected experience
After this step will either refine the initial solution OR a fresh look at the problem
What is the extended actuarial control cycle
There is also an extended Actuarial Control Cycle separating insurance (actuarial risks like size of claims) to investment processes
What are the two forms of actuarial investment advice generally given
1: To help clients construct a benchmark investment, and identify least risk strategy. Process is to meet clients, give advice, explain consequences, and write a report on this advice. ALWAYS identify the least risk investment strategies.
2: To give advice on how to outperform the benchmark return. Key assessment here is objective of client - can only win if others on market have different objectives
When giving investment advice what are key practices
Advice must eb formally given
Client needs to understand the consequences of all decisions
Communication to non experts is key here
Always emphasize the randomness of the markets.
What category of theory can be difficult to incorporate in a model
It’s very hard to incorporate the reflexive nature of theories into your model. Human nature is to follow each other, follow cascades or theories when they become widespread.
Define neutral theories
Neutral Theories: Theories were no one, or some, or everyone believing in the theory has no impact on the phenomenon Ex: theory of compound interest.
Define Reflexive theories
Reflexive Theories: So no one, or some, or everyone believing in the theory has an impact on the phenomenon. Reflexive theories can be divided into self-fulfilling theories, self-negating theories or a mix. Self fulfilling means the more that believe in it the more prominent it is. Self negating is the more people believe it the less true it becomes.
Give an example of self fulfilling theory
Rational self-interest hypothesis (humans act rationally when making decisions involving their finances ) in economics…those who believe it act more selfishly than those who do not.
Give an example of a self negating theory
Ex self negating: Any theory which claims a particular financial instrument offers
unusually low risk relative to its returns will tend to be self-negating: as demand for the investment ups its price, reducing expected returns and increasing its risk.
What are the key attributes of an investor
The investor objectives are more important than the investment opportunity - reward and risk are defined by investor viewpoint.
Goal is “the highest possible return within an acceptable level of risk”.
Need to understand investor constraints.
Every individual will have an optimum strategy unique to them.
Typically investors fund accumulate to meet liabilities so what aspects of investments and liabilities must be considered?
Nature of liabilities – real, monetary, static, going up with inflation?.
Term of liabilities
Currency of liabilities
Uncertainty in timing
Surplus
Regulation and Statutory Rules
Taxation
Expected Return from Assets
Contractual obligations
Ethical
Competitors
What does system T stand for
Security, Yield, Spread (diversification), Term, Exchange rate, Marketability Taxation.
Name lots of investment types
Cash, Money market instruments, government bonds, Corporate fixed interest bonds, index linked bonds, equities, property, currency (no income), commodities (no income), derivative instruments, pooling vehicles, other things
Why is CAPM or efficient frontier not practical?
In reality you won’t know the inputs for CAPM or the efficient frontier optimisation, hence outputs cannot be estimated accurately.
If you’re just solvent what should investment strategy be?
You only have funds available to meet your liabilities you should take MRP only. You do not have the capacity to take risks.
What are the embedded risks in cash, bonds, equities, property and derivatives
Cash - small risk: counterparty risk and inflation risk are embedded
Bonds - Counterparty risk and inflation risk
Equity, property, derivatives - No promises, higher risk, equity risk, property risk etc
Why does one have to be wary of using historical data?
Past behavior has to be interpreted as a reflexive model
Knowledge of the past affects the future so future will be different.
Data might look very different as economies were very different
Also remember in investing you’re trying to outwit and win over others and normally everyones relationships and key relationships will start based on historical data.
Define a bond
A bond is a negotiable loan raised by some body, with generally fixed interest payments and redemption date (“fixed interest bonds”). There are several types.
So income from bonds is coupon payments and then there is a redemption amount at the end of the term. They are contracts to be enforced - need reliable parties.
Government bonds are gilts
They have low dealing costs generally