Risk-free rate of interest

Given the current economic conditions I don't think we should view treasury bills as being risk-free, especially ones from the USA.

I wonder what would happen if I said this in the exam followed by advice to switch 33% of their assets to silver and gold? Bet i'd get no marks, but actually this isn't such bad advice for an individual!

 

I wouldn't risk it if I were you!

I expect government bonds (particularly in developed Western economies) are pretty close to risk-free in the currency in which they're denominated: I'm not sure of the appetite of any government to default, as opposed to simply printing money. At the moment, "printing money"/quantitative easing seem to be the flavour of the day. Of course, governments are currently all too happy to encourage inflation: the picture may be different in the (not-too-distant) future when the quantitative easing has caught up with, and perhaps overtaken, deflationary influences. The inflation introduced will then make it easy enough to meet the fixed interest government bond liabilities in any case. (On the other hand, printing money to pay off inflation-linked bonds could have the potential to be more inflationary...)

In general, government bonds will be held as a match for fixed liabilities in that currency. To swap into silver/gold would effectively introduce currency mismatching. You would only do this to the extent that you want to reduce your matching anyway, and so could go for a variety of different investments, of which gold and silver are but two. So I would have thought that the decision to go into such commodities is a separate one from that to decrease currency matching.

More views welcome!

 

My gold and silver view is based on advice I might give an individual. It assumes a worst case scenario were "cash" becomes virtually worthless!

You are right though, probably not appropriate for the exam!!!!

 

I guess we could perhaps give a semi-nod to the current environment by emphasising that it would normally be appropriate to use gilt yields as a proxy for the risk-free rate, or that the risk of default is usually considered to be close to nil for a government in a developed economy.

A similar issue crops up when if we're asked to consider risk premia on long duration swap rates, where breakeven rates have thrown up negative spreads recently. This is less likely to come up though.

Just hoping that it's going to be a nicely balanced exam next week.

 

Don't think you'd want to recommend a change to gold, I don't think that's an admissible asset under FSA rules!?

 

Pretty sure you're right sheppard. avanbuiten has said though that this is what he might advise an individual rather than a company. Of course that being the case then I'm not sure why it's in an ST5 thread - or indeed any actuarial exams thread - we are after all actuaries (or training to become them) not IFAs.

 

IFA or Actuary.... the profession would like us to diversify and work in new markets/industries. It's a valid question

 

Agreed.

Don't think it is outrageous for an actuary to give individual advice.
Wrong subject I know, but there have been exam questions on individual investment/savings advice in CA1, CA3, ST4 at least.

I also remember a ST4 Assignment question which asked for pros and cons of various investments including gold and "in a forest". Personally, I thought it was a bit silly, but such is writing actuarial exams.