CFA III SS 5 Institutional Wealth Management

  1. Underwriting Cycle
    • For non-life investors, after a catastrophe, insurers tighten underwriting standards and increase premiums
    • Leads to higher market profitability
    • More competitors, compete on premiums and standards, so each is lowered again
  2. Disintermediation
    • As rates rise, life insurance policy holders borrow against the policy or surrender the policy
    • Creates high liquidity demand at a time when asset (bond) prices are falling
    • LI have to sell assets at their least valuable to meet liquidity demand
  3. Purpose, source of funds, and spending requirement for the following foundations:
    • 1. Independent
    • 2. Company sponsored
    • 3. Operating
    • 4. Community

    • 1. Purpose: Grants to charities, education, religion
    • 1. Source: Single private donor or family
    • 1. Spending: 5% of assets, spending requirement excludes fund management fees
  4. 2. Purpose: Grants to charities, education, religion; aligned with corporate beliefs - ex. Walmart Foundation
    • 2. Source: Corporate sponsor
    • 2. Spending:¬†5% of assets, spending requirement excludes fund management fees
  5. 3. Purpose: Fund an organization, such as a museum or zoo
    • 3. Source: Usually individual or family, but can be a group
    • 3. Spending: 85% of dividend and interest income for 2% tax; if spend another 3.33% of assets, 1% tax
  6. 4. Purpose: social, educational, religious
    • 4. Source: general public and large donors
    • 4. Spending: None
  7. All only taxed on unrelated business income (UBIT), such as a gift shop in a museum
  8. How do the following affect the risk tolerance of a defined benefit plan?
    • 1. funded status
    • 2. sponsor's financial health/profitability
    • 3. sponsor and fund's success correlation
    • 4. plan features, such as early retirement and lump sum option
    • 5. age of workforce, number of active lives
    • 1. over -> higher RT
    • 2. low debt ratio and high profitability -> higher RT
    • 3. low correlation -> higher RT
    • 4. availability of options -> lower RT
    • 5. younger and more active lives -> higher RT
  9. Leverage Adjusted Duration Gap (LADG)
    LADG = Durationassets - (Liab/Assets)*DurationLiab

    • LADG < 0 implies Dassets¬†< DLiab
    • If < 0 and rates increase, net worth increases because assets are less sensitive than liabilities to the rate change.
  10. Cash Balance Plan
    • Similar to a defined benefit plan in that each participant has a cash balance
    • Each year the balance increases due to a pay credit (reflects years of service) and an interest credit (usually based on treasuries)
    • Participant can typically take balance as a lump sum at retirement
  11. Employee Stock Ownership Plans (ESOPs)
    • Defined contribution plan that invests in the company stock
    • ESOPs are not subject to the typical prohibition against owning employer stock in a retirement plan
  12. Foundation Return Objective
    • Typically maintain real value of fund and meet spending requirements
    • Return = (1 + mgmt fees)(1 + spending)(1 + inflation)
  13. Four factors affect life insurance risk tolerance
    • valuation concerns: market volatility can lead to a surplus write-down, which would lower risk tolerance (ability) and create a capital adequacy problem
    • cash flow volatility: loss, delay, or volatility in collecting income affects timely reinvestment
    • reinvestment risk: risk of reinvesting coupons at a lower rate. Prevalent in annuity business
    • credit risk: managed through credit analysis and portfolio diversification
  14. Sources of benefits in defined benefit plan, and how to hedge them
    • Accrued: payments to retirees/inactives and payments earned by active participants for past service. If indexed to inflation, hedge with TIPS, otherwise use nominal
    • Future: earned by active participants through future service, wage increases, and new entrants. Hedge wage increases with equities. Use nominal and real bonds to hedge future service, depending on structure of plan payments.
Card Set
CFA III SS 5 Institutional Wealth Management