Week 6 - Liability-driven investing

Question 1

what are the liability-driven strategies?

Answer 1

select assets so that cash flows are equal to or exceed the institution’s obligation

Question 1

What is the definition of a liability?

Answer 1

A liability is a cash outlay that must be made at a specific time to satisfy the contractual terms of an issued obligation

Question 2

What are the 4 libailities types?

Answer 2

1 - Know,known
2- known, uncertain
3- uncertain, known
4- uncertain uncertain

first is the amount, second is the timing

Question 3

What are the liquidity concerns?

Answer 3

An institution must be prepared to have sufficient cash to satisfy its obligations (liability)
The person holding the obligation against the institution may have the right to change the nature of the obligation, perhaps incurring a penalty, or borrow against a policy
In addition, an institution has to be concerned with possible reduction in cash inflows

Question 4

What are the two goal of the assets/liability management?

Answer 4

Two goals are to earn an adequate return on investments and to maintain a comfortable surplus of assets beyond liabilities

Question 5

What are the 3 surpluses of the institutions?

Answer 5

economic, accounting, and regulatory.

Question 6

What is an economic surplus?

Answer 6

Economic surplus is the difference between the market value of all its assets and the market value of its liabilities

Question 7

What is the accounting surplus?

Answer 7

is the surplus of assets over liabilities as reported in financial statements based accounting principles (e.g. GAAP)

Question 8

What are the 3 methods for reporting the accounting surplus?

Answer 8

amortized cost or book value accounting
market value
or the lower of cost or market value

Question 9

What is the Regulator surplus?

Answer 9

is the surplus of assets over liabilities as reported based on regulatory accounting principles

Question 10

What is an immunitization strategy?

Answer 10

the investment of the assets such that the existing business is immune to a general change in the rate of interest

Question 11

What is a Immunization risk?

Answer 11

refers to the potential for a mismatch between the duration of a portfolio and the investor’s time horizon or liability duration

Question 12

What are the 2 Terms Fong and Vasicek note will the relative change in portfolio value depend on in case of a arbitrarily yield curve shift?

Answer 12

The characteristics of the investment portfolio
The nature of the change in the shape of the yield curve

Question 13

what is Contingent immunization?

Answer 13

A strategy that consists of identifying both the available immunization target rate and a lower safety net level return

Question 14

What are the two strategies to satisfy a liability stream?

Answer 14

Multi-period immunization
Cash flow matching

Question 15

What is a Multi-period immunization strategy?

Answer 15

Decompose the portfolio payment stream in such a way that each liability is immunized by one of the component streams

Question 16

What is a cash-flow matching strategy?

Also called a dedicated portfolio strategy

Answer 16

The approach can be summarized as follows:
a bond is invested in for an amount and with a maturity to match the last liability stream
the remaining elements are reduced by the coupon payments of this bond
another bond is invested in for the reduced amount of the next-to-last liability, and this process is continued

Question 17

What is symmetric cash matching?

Answer 17

handles situations in which CFs occur before and after liability due dates, allowing for the short term borrowing of funds

Question 18

What is Combination matching?

Answer 18

combines both strategies: creates a portfolio that is duration matched with the added constraint that it is cash-flow matched for a few initial years

Question 19

What are the deterministic models?

Answer 19

Models in which both the liabilities and assets cash flows are known

Question 20

What are the stochastic models ?

Answer 20

Models in which either liability or assets or both are uncertain

These model incorporate an interest rate models

Question 21

What are the 2 goals of a liability driven investing manager?

Answer 21

Produce added returns
Keep the portfolio aligned with the liability schedule