Chapter 5 revised (1) - Chapter 5 Review Questions Math...

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Chapter 5 Review Questions Math 3650 1. Some examples of interest rate risk that insurance companies face are: Prepayment risk Market Risk Disintermediation Risk Pricing Risk Reinvestment Risk Briefly describe these interest rate risks. 2. List 5 factors that influence interest rates. 3. Briefly define the following key short term interest rates: Prime Rate Federal Funds Rate The Discount Rate 4. How does the government affect short term and long term interest rates? What drives the government policy on the direction in which it tries to move interest rates? 5. What is the difference between nominal interest rates and real interest rates? Which should be used to discount cash flows? If the nominal rate is r and the inflation rate is i, give the formula for calculating the real interest rate. 6. What is meant by the term structure of interest rates?
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Chapter 5 Review Questions -Math 3650 7. The yield curve is often increasing, or positively sloped. (with longer term interest rates higher than shorter term interest rates). Briefly describe two theories for why this is the case. 8. What is an inverted yield curve? Inverted yield curves are associated with what economic environment? 9. What economic conditions would produce a relatively flat yield curve? 10. What are Treasury STRIPS? What are Spot rates? 11. US Treasury spot rates are as follows: 1 year 6.3% 2 year 6.7% 3 year 7.0% 4 year 7.5% 5 year 8.0% Calculate the yield to maturity of a $1000 5 year US Treasury note paying 7% annual coupons. Redemption value equals par value.
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Chapter 5 Review Questions Math 3650 Answers 1. Prepayment risk is the risk that investments owned by the insurance company may be paid off early, and the proceeds from the prepayments will be reinvested at lower interest rates. This would lower the profitability on long duration contracts that the insurance company sold if the credited interest rates on those policies could not be lowered as well. Some investments which contain prepayment risk include mortgages, mortgage backed securities, asset-backed securities (credit cards and car loans), and callable bonds.
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