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Insurance and Investment Risk (The measurement of investment returns (Bond…
Insurance and Investment Risk
Hedging is generally approached by using derivatives and many product choices exist
Credit default swaps
are a type of credit derivative. They are contracts which allow one party (the protection buyer) to buy protection from another party (the protection seller) in case a reference obligation from a legal entity defaults.
As many banks typically offer insurance products to customers which include wealth management, term assurance, annuities, property and payment protection insurance products, they therefore face
insurance risk
with respect to the potential of claims resulting under the insurance policies under which they are obligated.
Investment Risks
would be financial assets and liabilities relating to investment contracts and asset-backed insurance contracts which may be treated under a different international accounting standard.
Rates of return from the main asset classes
Equity investment
Equity is bought to benefit from, dividends and increases in share price
Main risk is the stock losing some/all of it's value
Commodities - 3 sources of returns
(Spot) Price moving up after buying a commodity.
Through derivatives
Roll yield - future roll contract cheaper than original contract
Fixed interest securities(ie bonds)
Higher return than cash
Affected by multiple factors as explored above
Bonds from lower quality issuers (companies with poor credit ratings) will have higher yields than higher quality issuers (such as governments), reflecting the different levels of default risk.
Cash deposits
High Liquidity
Faces inflation & interest rate
Low Return
Alternative investments ie: fine wines, antiques, stamps and coins,
Expensive to store
Low marketability
Difficult to value - requires expert knowledge to do so
The measurement of investment returns
Bond prices can be affected by
Economic prospects
Government policy decisions
Changes in inflation
Changes in interest rates generally.
Equity Risk/Capital Risk
The risk that an investor’s equity investments will depreciate because of stock market dynamics causing a loss.
Interest rate risk
a) A rise in interest rates is a risk for a borrower who is borrowing at a variable rate.
A saver with a variable rate account faces the risk that interest rates will fall in the future.
Commodity Risk
Refers to the uncertainties of future market values and of the size of the future income, caused by fluctuation in the prices of commodities.
Currency risk
A UK resident (that is, someone whose home currency is sterling) who buys stocks or bonds in other currencies, for example the euro or the US dollar, faces currency risk.
Property risk
A sale can only be made if a buyer can be found. Prices may fall if this occurs.
In finance,
tracking error
is a measure of how closely a portfolio follows the index to which it is benchmarked
This occurs partially due to fees paid to the manager
Measured by the root-mean-square of the difference between the portfolio and index returns.