Q3, v) Can someone please help in understanding the impact of fall in interest rates to the proposed investment strategy with an example? Somehow I am finding it hard to understand the concept with change in economic conditions and its impact on the overall business (assets as well as liabilities).. For instance
"If the company invested assets longer than liabilities and interest rates were to fall, then the value of the assets would rise
resulting in additional capital if interest rates fall
So, with this strategy, the company would have to hold less required capital against the fall in interest rates risk"
Here they say, additional capital first but then say less capital required. So it is a bit confusing!
If assets are longer in duration than liabilities, then interest rates falling will mean that assets go up by more than liabilities go up, which basically means the company has made some profit (increased surplus) from this event and it has increased the available capital of the company. Since this event improves the capital position of the company, then it has to hold less required capital (since required capital protects against adverse events).