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How are assets and liabilities considered when investing?

0 votes
asked Nov 9, 2017 in BUS 4027W - Actuarial Risk Management by Rowan (4,010 points)

I don't think I understand how assets and liabilities are looked at for investment purposes. I initially thought that the investment fund manager will look at the liabilities of EACH individual/institution and then match them with appropriate assets. But the notes make it seem like the manager looks at the liabilities as a whole. That is why they said that the risk of mismatching is a global rather than an individual issue and so provisions should be established on a global basis. Could you please explain this?

1 Answer

+1 vote
answered Nov 9, 2017 by ErichMaritz (500 points)
selected Nov 12, 2017 by Richard van Gysen
Best answer

EM: For calculating what the notes refer to as “individual provisions”, a formula or discounted cashflow model might be used. Implicit in this calculation is an assumed least-risk matching strategy, e.g. to discount cashflow with a risk-free yield curve, we implicitly assume we are matching with risk-free bonds. However, the total actual portfolio may look quite different. It may include credit assets and/or property. In such a case the actual portfolio carries more risk than the least-risk portfolio and additional provisions may have to be set up. In practice the least-risk portfolio would be derived with reference to the overall liability (sum of individual liabilities).