2015 Spring Q30 B

wilsonchan18wilsonchan18
in CIA.MfAD

Hi,

May I know why the Exam Report say we should prefer A by looking at the Reinvestment Risk?
I dont know where I can locate the Reinvestment Risk as there are only 3 items from Explicit approach: AL Mismatch, Timing and Credit Risk Margin.

Thanks and Warm Regards,
Wilson

Comments

  • Staff-T1Staff-T1

    Hi,

    Yes you are right; it's not very clear. My take on this is that when you invest in bonds, you would need to "roll" upon maturity to a newer bond by taking the proceeds from your matured bond and buying a freshly issued bond. However, if interest rates are lower when you need to "roll" then you would not get the return that you would like. This is the reinvestment risk that I think is being implied. With a longer duration, you wouldn't need to roll as often vs a shorter duration bond which lowers reinvestment risk.

  • wilsonchan18wilsonchan18

    Thank You!

  • oxalisoxalis

    Can you please also explain c) why we prefer strategy B?

    Less volatility in assets - is it because of low yield?
    Less duration mismatch- based on calculation from a)?
    Less volatility in liabilities- is it because of low yield?
    Less credit risk (100 bps vs 50 bps) - given
    Lower credit risk and timing risk margin, which results smaller investment MfAD - based on calculation from a)?

    Thank you

  • Staff-T1Staff-T1

    Less volatility in assets - It's because B has a lower duration which means it is less sensitive to changes in the interest rate
    Less duration mismatch - It's because the duration of assets in B is closer to the duration of liabilities
    Less volatility in liabilities - I don't agree with this point. The liabilities have the same duration in both scenarios so I can't see how there would be less volatility in the liabilities in scenario B
    Lower credit risk and timing risk margin - Yes

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