April 2014 Q3

[Tomahawk]

The Question:
After a protracted recession, a new government has been elected in Actuaria. The austerity programme followed by the previous administration was not popular with the electorate and so the incoming finance minister has proposed a package of measures designed to inflate the economy by improving general confidence from restoring the “feel good” factor.
Whilst the proposals are popular with the tabloid press, you have been approached by an economic journal to write an open letter to the government that sets out the consequences of the measures in a more balanced manner.
Outline the points that you would make on the consequences for the financial markets and for the economy of a high inflation environment and the implications for assets and liabilities of both insurance companies and pension funds.

24 marks available. Having looked through the examiner's report and summarised the points included I am struggling to see how one could have scored 24 marks for the question. Being quite generous I can tease out 14 separate points being made.

Methods might not work (this is not answering the question)
Inflation will cause bond yields will rise [1]
Inflation will cause equities to rise [2]
Inflation will weaken the domestic currency [3]
To keep inflation low the central bank may raise rates, the fear of which may damage confidence [4,5]
Environment might not be highly inflationary (this is not answering the question)
High inflation has historically meant increased volatility in stock markets [6]
Higher rates will cause bond yields to rise [7]
Higher rates will help strengthen currency [8]
Higher rates encourage saving and reduce disposable income [9]
Corporates that can expect to do well from the inflationary environment may have outperforming equities and bonds [10]
If inflation is expected to continue the yield curve will be steep (this is not answering the question)
Pension funds are long term so more impact [11]
Inflation will cause real pension liabilities will increase [12]
Assets will move according to market perceptions (this is not answering the question)
Assets will increase in nominal value due to inflation, this is of benefit to insurers holding assets [13]
Instability may cause lack of confidence with potentially “enormously bad” consequences [14]


My question is:
Am I being too harsh in my marking? Is stating that if the market perceives the measures as causing assets to appreciate that assets will appreciate really worth a mark?
Am I being too brief in my summary? Should i explain why domestic currency might weaken due to inflation thereby gaining two marks for this point?

 

[Gresham Arnold]

Hi Tomahawk

I don't teach SA6, but in general in the later actuarial exams I expect a simple statement to score a 1/2 mark.

Looking at the Examiners' Report I reckon there are around 35 separate sentences or paragraphs. So if each scored a 1/2 mark, there would be around 18 marks available.

However, within some of these sentences / paragraphs there are a number of simple statements. I've only done a very rough count, but I reckon there are 50+ there. So on the basis of 1/2 mark for each, I reckon there are more than 24 marks available in the Examiners Report.

In summary, I think there will be a series of half marks available for at least some of the 14 issues that you raise.

I hope this helps

Best wishes
Gresham

 

[Colin McKee]

Hi, I fully agree with what has been written on this thread. in fact in SA6 there are a lot of 1/2 marks, but plenty of full marks and that would have been the case here, so the question would have ended up having a good surplus of marks in the end.

 

[Colin McKee]

PS - in relation to your last point, th answer is YES. You should always look at the marks, and if its a big question and you dont have enough, start explaining. So explain why the currency would weaken with inflation (PP Parity?) Also explain why it may strengthen (prospect of higher short term rates). Explain why bonds would fall on inflation and why the IRP might increase. Explain why equities are not directly impacted by inflation as the dividends grow more quickly, but are discounted at a higher nominal interest rate. But that they are impacted by knock-on effects such as raising of short term rates to counter inflation or to protct the currency. (Defaults, volatility, uncertainty ...) Many of the point you have mentioned are worth 2, 3 or 4 marks if fully explained. And many of them appear in reasonable detail in the ER.
Hope this helps.

 

[Tomahawk]

Thank you both for your replies. It is of help to me that you both feel the ER has enough to get the 24 marks. I honestly struggled to believe it had.

That is not to say I'm disappointed with the ER but rather that I see that the emphasis is on explicitly making points that cover the basics more completely even if this requires overlapping with other points (but from a different perspective) and making further simple assumptions/stating exceptions.
I think I was aspiring for too much insight and separation in my answers leaving me with less to write about.

Hopefully, this will help my SA6 efforts next week.