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MidtermOneAnswers - ACTUARIAL SCIENCE 445/845: Asset...

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ACTUARIAL SCIENCE 445/845: Asset Liability Management Midterm One - Fall 2010 ANSWERS Aids: Calculator, Answer all questions in the space provided. Show your work. Name: ____________________ Marks: _____________________/30 ID#: _____________________ Course (445 or 845):___________ Concept Questions 1. [4 marks] Briefly explain what is meant by reinvestment risk. Explain why investors holding callable bonds and mortgage-backed securities are exposed to reinvestment risk. Answer: The return obtained when reinvesting the cash-Fows produced by a fixed income security depends on the interest rates prevailing when these cash-Fows are reinvested. Reinvestment risk is the risk that the interest rates will be low when the cash-Fows become available for reinvestment. Aside from the reinvestment risk associated with the coupons, callable bonds are exposed to reinvestment risk because the issuer can call the bond before maturity, forcing the bondholder to exchange the bond for the call price. The issuer will be more likely to do this when interest rates are low, i.e. when it can refinance its debt in the market at a lower rate. Similarly, mortgage-backed securities (MBS) are exposed to reinvestment risk because the holders of the mortgages can repay the principal on their mortgages (in whole or in part), which will cause principal on the MBS to be repaid early. Again, this is more likely to occur when interest rates are low, and homeowners can refinance their mortgages at lower rates. 2. [4 marks] State the three immunization conditions from the classical Redington
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This note was uploaded on 02/23/2012 for the course ACTSC 445 taught by Professor Christianelemieux during the Fall '09 term at Waterloo.

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MidtermOneAnswers - ACTUARIAL SCIENCE 445/845: Asset...

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