April 2019 Q5

[rlsrachaellouisesmith]

Hi

In (ii) of this question I wondered why in particular we would want to invest in liquid bonds with term 10 years in the non-unit reserve. I understand the policy has term 10 years. But this will be a large initial cost so that the interest payments from the bonds were sufficient to cover the difference between charges and expenses throughout the term?

Would there be any need for the bonds to be index linked rather than fixed interest? or would this just depend on the mismatch in charges and expenses - I guess it would just depend on this.

Thank you,

Rachael

 

[Mark Willder]

Hi

In (ii) of this question I wondered why in particular we would want to invest in liquid bonds with term 10 years in the non-unit reserve. I understand the policy has term 10 years. But this will be a large initial cost so that the interest payments from the bonds were sufficient to cover the difference between charges and expenses throughout the term?

Would there be any need for the bonds to be index linked rather than fixed interest? or would this just depend on the mismatch in charges and expenses - I guess it would just depend on this.

Thank you,

Rachael

Hi Rachael
I agree that 10 year bonds are a rather odd choice of investment to single out here. I think it's a typo. ASET phrases it slightly differently so that we might need bonds of up to 10 years.
The choice of bonds will depend on the timing of the charges and expenses. The question doesn't give us any detail on these, so we probably shouldn't spend too much time on this in the exam. It's reassuring to see that full marks can be obtained without covering the point you mention in the solution.
But if the contract has big up front charges then it might be reasonable to hold some of this in 10 year bonds to cover the termination expenses at the end of the contract.
Yes, if we were holding bonds to cover future expenses then index-linked bonds would make sense if they were available.
Best wishes
Mark

 

[rlsrachaellouisesmith]

Hi Rachael
I agree that 10 year bonds are a rather odd choice of investment to single out here. I think it's a typo. ASET phrases it slightly differently so that we might need bonds of up to 10 years.
The choice of bonds will depend on the timing of the charges and expenses. The question doesn't give us any detail on these, so we probably shouldn't spend too much time on this in the exam. It's reassuring to see that full marks can be obtained without covering the point you mention in the solution.
But if the contract has big up front charges then it might be reasonable to hold some of this in 10 year bonds to cover the termination expenses at the end of the contract.
Yes, if we were holding bonds to cover future expenses then index-linked bonds would make sense if they were available.
Best wishes
Mark

Thank you Mark, I shall not dwell on it too much. But up to 10 years makes much more sense. Thank you