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　　6. (5 points) ABC is a large, well- established multi- line insurance company with triple-A ratings
　　from all major rating agencies. XYZ, a small wholly owned subsidiary of ABC, starts operation
　　on the morning of December 31, 2001, with paid- in capital of $10 million. XYZ issues a oneyear
　　Guaranteed Investment Contract (GIC) and invests both the proceeds from the sale of the
　　GIC and the paid- in capital in a diversified portfolio of stocks.
　　You are given the information below and the Standard Normal Table on the next page.
　　Guaranteed Investment Contract:
　　?  Maturity Date: December 31, 2002
　　?  Face Value: $100,000,000
　　?  Net Proceeds from the Issue: $99,125,000
　　?  Guaranteed Interest: 3.75%-with semi-annual compounding
　　?  Method of Payment: Principal and accumulated interest due on maturity date
　　Diversified Investment Portfolio:
　　?  Market value, as of close of market on December 31, 2001: $108,762,500
　　?  Purchase price (cost basis) of portfolio (including brokerage commissions): $109,125,000
　　?  Expected annualized continuously compounded rate of return: 8.5%
　　?  Standard deviation of annualized continuously compounded rate of return: 20.0%
　　?  Dividends will be reinvested.
　　One-Year Treasury Rate:
　　?  Rate as of December 31, 2001: 2.17%-with semi-annual compounding
　　(a) (1 point) Describe three different, but theoretically correct, methods for estimating the
　　value of the future liability cash flows, in the absence of observable market prices.
　　(b) (4 points) Calculate the fair value of the GIC issued by XYZ as of December 31, 2001:
　　(i) if the payment of principal and interest is guaranteed by ABC and backed with
　　specific assets placed in a trust;
　　(ii) if there are no guarantees from the parent.
　　Show your work.
　　COURSE 8 FINANCE - 9 - STOP
　　FALL 2002
　　Morning Session
 
　　7. (8 points) You are an analyst at Reliable Ratings Corporation, a company that rates propertyliability
　　companies. Biking Liability Insurance Company (BLIC) has traditionally issued
　　motorcycle insurance and has recently begun to sell airplane insurance, necessitating a review of
　　its rating.
　　Currently BLIC’s reserve amounts are $750 million for the motorcycle insurance line and $100
　　million for the airplane insurance line. Your analysis reveals the following expected claims
　　distribution for the next year:
　　Motorcycle Airplane
　　Claim Amount
　　($ million)
　　Probability Claim Amount
　　($ million)
　　Probability
　　250 70% 10 25%
　　1,000 25% 40 50%
　　2,000 5% 250 25%
　　Given the characteristics of these lines, you assume that there is no correlation in the claims
　　between the two lines.
　　Local regulations require that capital be held such that the expected policyholder deficit does not
　　exceed 10% of expected losses.
　　A quick analysis of the asset portfolio reveals that BLIC is holding $1.5 billion in cash with no
　　other securities in the portfolio.
　　Reliable Ratings assigns ratings based on the following minimum ratios of recorded capital to
　　risk-based capital.
　　Credit
　　Rating
　　Minimum
　　Capital Ratio
　　AAA 2.50
　　AA 2.25
　　A 2.00
　　BBB 1.75
　　BB 1.50
　　B 1.25
　　CCC 1.00
　　(a) (1 point) List criteria that a risk-based capital methodology should satisfy in order to
　　ensure equity to all parties.
　　(b) (4 points) Assign a credit rating to BLIC. Show your work.
　　(c) (1 point) Explain the implications to required capital of assuming no correlation between
　　the motorcycle line and the airplane line.
　　(d) (2 points) Describe how the owners of BLIC hold a position similar to a stock option.
　　COURSE 8 FINANCE - 9 - GO ON TO NEXT PAGE
　　Fall 2002
　　Afternoon Session
　　** BEGINNING OF EXAMINATION **
　　AFTERNOON SESSION
　　Beginning with Question 8
 
　　8. (20 points) You are the Treasurer of SPE Corp, a life insurance company with a liability profile
　　consisting of 70% deferred annuities and 30% traditional life. Total assets are $1 billion.
　　Six months ago, SPE Corp purchased at par $100 million of senior secured debt issued by Huge
　　Energy Corp, rated Baa. The bond pays a 10% annual coupon and matures in five years.
　　When SPE Corp purchased these bonds, a stand-alone CreditMetrics TM calculation for this bond
　　was performed using a one- year time horizon and the following data.
　　1-Year Average Transition Matrix
　　INITIAL RATING AT YEAR END (%)
　　RATING Aaa Aa A Baa Ba B Caa-C Default
　　Aaa 91.82 7.37 0.81 - - - - -
　　Aa 1.21 90.76 7.67 0.28 0.08 - - -
　　A 0.05 2.49 91.97 4.84 0.51 0.12 0.01 0.01
　　Baa 0.05 0.26 5.45 88.54 4.72 0.72 0.09 0.17
　　Ba 0.02 0.04 0.51 5.57 85.42 6.71 0.45 1.28
　　B 0.01 0.02 0.14 0.41 6.69 83.37 2.57 6.79
　　Caa-C - - - 0.62 1.59 4.12 68.04 25.63
　　Illustrative Recovery Rate by seniority class (% of face value, i.e., par)
　　SENIORITY CLASS MEAN ($) STANDARD DEVIATION (%)
　　Senior Secured 55 30
　　Senior Unsecured 50 25
　　Senior Subordinated 40 25
　　Subordinated 35 20
　　Junior Subordinated 20 10
　　Illustrative one- year forward curves by credit rating category and one-year forward values for a
　　Baa bond plus coupon
　　CATEGORY YEAR 1 (%) YEAR 2 (%) YEAR 3 (%) YEAR 4 (%) BOND VALUE ($)
　　Aaa 3.5 3.75 4.0 4.25 130.97
　　Aa 4.0 4.25 4.5 4.75 128.94
　　A 5.0 5.5 6.0 6.5 122.41
　　Baa 6.5 7.0 7.5 8.0 117.03
　　Ba 8.5 9.5 10.5 11.5 106.14
　　B 11.0 12.0 13.0 14.0 99.04
　　Caa-C 14.0 16.0 18.0 20.0 85.34
　　COURSE 8 FINANCE - 10 - GO ON TO NEXT PAGE
　　友谊是不会有感情的破产和快乐的幻灭的。爱情如果献出的超过本身的能力，最后就会接受多而献出少了。这在男女双方都一样，而友谊则只能增长。——高顿网校名人感触

 

 
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