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Market risk

M

Mbotha

Member
I always think I understand market risk until I try and apply it in a question :confused:

In A2015 Q1(ii), market risk is mentioned in the solution as applying to only the UL pension business... except if interest rate risk is included in market risk, in which case it also applies to the immediate annuity business.

Market risk basically comes down to the risk of assets moving differently to liabilities following market movements (interest rate, equities, property exchange rates). So:
  1. Why is the distinction made to include interest rates in this definition? Doesn't market risk include this anyway?
  2. Why does the answer only include the immediate annuities if interest rates are included in the definition (and why is it not necessary to be included for the UL pensions)?
  3. Am I right in saying that immediate annuities are likely to be matched by bonds and a matching adjustment could apply (if sufficiently predictable, like no surrender values)? So the market risk should be very small here, right?
 
Hi


I always think I understand market risk until I try and apply it in a question :confused:

In A2015 Q1(ii), market risk is mentioned in the solution as applying to only the UL pension business... except if interest rate risk is included in market risk, in which case it also applies to the immediate annuity business.
The solution distinguishes between 'equity market' risk and interest rate risk. Both sit under market risk. The annuities will be backed by bonds and so will be impacted by interest rate movements (to the extent that these do not match the liabilities exactly).

Market risk basically comes down to the risk of assets moving differently to liabilities following market movements (interest rate, equities, property exchange rates). So:
  1. Why is the distinction made to include interest rates in this definition? Doesn't market risk include this anyway?
    the market risk definition is broken down into interest rate risk and equity market risk which both fall under market risk .
  2. Why does the answer only include the immediate annuities if interest rates are included in the definition (and why is it not necessary to be included for the UL pensions)?
    The unit-linked pensions could be invested in bonds and so would be exposed to interest rate risk. So yes in the exam you could get marks for saying that interest rate risk would affect both products (if UL pensions included bonds). However a large part of the UL pensions investments are likely to be equities, resulting in more exposure to equity market risk than interest rate risk.
  3. Am I right in saying that immediate annuities are likely to be matched by bonds and a matching adjustment could apply (if sufficiently predictable, like no surrender values)? So the market risk should be very small here, right?
    Yes, there would be virtually no equity market risk as like you say they would be invested in bonds.
 
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