Week 6 - Liability-driven investing Flashcards
what are the liability-driven strategies?
select assets so that cash flows are equal to or exceed the institution’s obligation
What is the definition of a liability?
A liability is a cash outlay that must be made at a specific time to satisfy the contractual terms of an issued obligation
What are the 4 libailities types?
1 - Know,known
2- known, uncertain
3- uncertain, known
4- uncertain uncertain
first is the amount, second is the timing
What are the liquidity concerns?
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
What are the two goal of the assets/liability management?
Two goals are to earn an adequate return on investments and to maintain a comfortable surplus of assets beyond liabilities
What are the 3 surpluses of the institutions?
economic, accounting, and regulatory.
What is an economic surplus?
Economic surplus is the difference between the market value of all its assets and the market value of its liabilities
What is the accounting surplus?
is the surplus of assets over liabilities as reported in financial statements based accounting principles (e.g. GAAP)
What are the 3 methods for reporting the accounting surplus?
amortized cost or book value accounting
market value
or the lower of cost or market value
What is the Regulator surplus?
is the surplus of assets over liabilities as reported based on regulatory accounting principles
What is an immunitization strategy?
the investment of the assets such that the existing business is immune to a general change in the rate of interest
What is a Immunization risk?
refers to the potential for a mismatch between the duration of a portfolio and the investor’s time horizon or liability duration
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?
The characteristics of the investment portfolio
The nature of the change in the shape of the yield curve
what is Contingent immunization?
A strategy that consists of identifying both the available immunization target rate and a lower safety net level return
What are the two strategies to satisfy a liability stream?
Multi-period immunization
Cash flow matching
What is a Multi-period immunization strategy?
Decompose the portfolio payment stream in such a way that each liability is immunized by one of the component streams
What is a cash-flow matching strategy?
Also called a dedicated portfolio strategy
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
What is symmetric cash matching?
handles situations in which CFs occur before and after liability due dates, allowing for the short term borrowing of funds
What is Combination matching?
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
What are the deterministic models?
Models in which both the liabilities and assets cash flows are known
What are the stochastic models ?
Models in which either liability or assets or both are uncertain
These model incorporate an interest rate models
What are the 2 goals of a liability driven investing manager?
Produce added returns
Keep the portfolio aligned with the liability schedule
