CAS Exam 6C Spring 2015, Question 30
Study guide: Exam 6C
A company is considering two different investment strategies:
- Strategy A: buy only high yield bonds
- Strategy B: buy only low yield bonds
The following information is given:
| Strategy A | Strategy B | |
|---|---|---|
| Asset duration | 4 years | 3 years |
| Liability duration | 2 years | 2 years |
| Coverage Ratio | 60% | 60% |
| Interest rate movement in runoff period | 100 basis points | 100 basis points |
| Discount rate based on portfolio | 4% | 3% |
| Credit Risk Margin | 100 basis points | 50 basis points |
| Discount rate including the interest rate margin | ? | 1.9% |
In addition, assume the following:
- For determining the timing risk margin, the duration of liabilities is shortened by 10%.
- Investment expenses are 0.
Part a (1.25 points)
Calculate the discount rate including the interest rate margin for Strategy A using the explicit quantification method.
Part b (0.5 points)
Provide two reasons for preferring Strategy A.
Part c (0.5 points)
Provide two reasons for preferring Strategy B.
No current syllabus covers this question; it is kept for the record.
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