I am confused after reading the solution contained in examiners’ report to question 1 (vi). The points mentioned in examiners’ report are all valid but the answer does not appear to me to be tailored to the specific question. Also it is unclear to me, why the examiners’ report says that the company may move out of corporate bonds as my understanding is that the issue here is of gilt-swap basis risk.
The examiners’ report is supposed to contain all points for which marks were awarded. If I mention the following points, as these are not in the examiners’ report, am I right in assuming that these would not have scored marks in the exam?
• Sell gilts portfolio and invest in interest rate swaps.
• Shorten the duration of gilts portfolio by selling long dated gilts in order to reduce volatility and enter in to a series of forward starting swaps to get the required duration.
• Using spreadlocks, the insurer can lock in current spread between a swap and an underlying government bond yield.
Other actions
• Model the gilt-swap basis risk and hold capital against this risk. The action it needs to take will also depend on whether it is using standard formula or an internal model.
• Matching adjustment may reduce this spread risk (provided that the insurer’s assets and liabilities qualify for matching adjustment). In addition, matching adjustment would allow the insurer to discount the liability at a higher rate so it needs to carefully assess whether it needs to sell its gilts portfolio at all.
The examiners’ report is supposed to contain all points for which marks were awarded. If I mention the following points, as these are not in the examiners’ report, am I right in assuming that these would not have scored marks in the exam?
• Sell gilts portfolio and invest in interest rate swaps.
• Shorten the duration of gilts portfolio by selling long dated gilts in order to reduce volatility and enter in to a series of forward starting swaps to get the required duration.
• Using spreadlocks, the insurer can lock in current spread between a swap and an underlying government bond yield.
Other actions
• Model the gilt-swap basis risk and hold capital against this risk. The action it needs to take will also depend on whether it is using standard formula or an internal model.
• Matching adjustment may reduce this spread risk (provided that the insurer’s assets and liabilities qualify for matching adjustment). In addition, matching adjustment would allow the insurer to discount the liability at a higher rate so it needs to carefully assess whether it needs to sell its gilts portfolio at all.