Course Code:               ACTS 3004     

Course Title:                 ASSET and LIABILITY MANAGEMENT I                                            

Course                          Type: Core

Level:                            3

Semester:                      2

No. of Credits:                3

Pre-requisites:              MATH 2275 & MGMT 3048

 

Course Rationale

 Actuaries today, in addition to their very traditional role in insurance, play a major role in the management of financial assets. They may be found managing funds containing stocks and bonds and may also be seen managing hedge funds.

The aim of this course is to develop amongst students’ good value judgment and effective leadership skills toward sound problem-solving and decision-making activities in the context of financial asset management. We also want the student to be more aware of Insurance Management and its contribution to the society. The chief goal is to provide thorough knowledge of theoretical and application concepts in both life and non-life insurance management.

This course addresses part of the requirements of the SOA examination in Financial Economics, which informs its content.

Course Description

This course covers topics in modern corporate portfolio theory. Topics include cost of capital, economic capital, sources of capital, bond pricing, derivatives pricing, interest rate models, and efficient markets. The course builds on the material in Financial Mathematics II, introducing further tools and techniques of asset/liability management, general product design, as well as issues of pricing, valuation and asset management and investments in financial security programmes.

Assessment is designed to encourage students to work continuously with the course materials. Active learning will be achieved through marked assignments supplemented by problem papers, allowing continuous feedback and guidance on problem solving techniques in tutorials and lectures. Assessment will be based on the marked assignments and in-course tests followed by a final examination based on the whole course. Software used in the actuarial field will be incorporated in the course so that students develop practical skills

 

Course Content

  • Review of macroeconomics;
  • Introduction to stochastic calculus and its use in risk management;
  • Duration, effective duration and key rate duration;
  • Convexity;
  • Immunization;
  • Traditional techniques of financial analysis;
  • Portfolio management;
  • Asset/liability management;
  • Valuation of financial derivatives;

 Learning outcomes

 At the end of these modules students should be able to:

A. Introduction to Stochastic Calculus

  • Define duration, modified duration, effective duration and key rate duration.
  • Calculate the duration measures of a portfolio.
  • Apply duration, convexity, and immunization measures to a portfolio.
  • Utilize the basic concepts of stochastic calculus and its use in valuation and risk management in both discrete and continuous time models.
  • Apply analytical and numerical solution techniques, including simulation.
  • Modern Portfolio Theory
  • Calculate the cost of capital for a venture or a firm using the most appropriate method for given circumstances and justify the choice of method.
  • Evaluate various profitability measures including IRR, NPV and ROE, etc.
  • Define and compare risk metrics used to quantify economic capital and describe their limitations.
  • Describe methodologies for allocating economic capital within a financial organization.

C. Asset/Liability Management

  • Define value-at-risk (VaR).
  • Calculate VaR for given portfolio.
  • Apply VaR in risk management of portfolio.
  • Define bootstrap.
  • Use bootstrap in calculating yields.

D. Valuation of Financial Derivatives

  • Define and explain the use of the following:

a. Options

b. Forwards

c. Futures

  • Define the cash flow characteristics of complex derivatives including exotic options, interest rate derivatives, swaps, and other non traditional derivatives.
  • Identify embedded options in assets and liabilities.
  • Evaluate the impact of embedded options on risk/return characteristics of assets and liabilities.
  • Use the Black-Scholes Merton pricing formula to price derivatives.

Cognitive skills, Core skills and Professional Awareness

  • Awareness of the principal statistical methods and models used in assessing problems in financial theory for actuarial work
  • Possession of the knowledge required to work in the area of finance in the actuarial context
  • The appropriate and rigorous use of mathematical modeling to formulate workable solutions to important financial problems

Assessment Criteria

Principles of Asset/Liability Management for Actuarial Science is assessed by combination of coursework (50%) and a single 2-hour written exam at the end of the semester (50%).

Assessment:                    In-course Tests                            40%

                                       Assignments                                10%

                                       Final Exam                                   50%

In-course Tests: Two 50-minute written papers (20% each) consisting of compulsory questions of varying length

Assignments:  Two papers to be handed. One paper on the first part of the course and the other on the second part of the course. Each assignment is worth 5%. Tutorial practice papers will be given every week to be handed in the next week. Tutorial papers are not graded as part of the course work.

Exam Format: One two-hour written paper with compulsory questions.

 

Teaching Methodology

Lectures:           Two lectures per week (50 minutes each)

Lab:                One two-hour computer lab per week.

 

 

Course Calendar

 

Week

Topic to be taught

Assessment

1

Introduction to Course/Course Overview

Introduction to stochastic calculus and its use in risk management

Problem Sheet #1 is given

2

Duration, effective duration and key rate duration

Problem Sheet #2; Solutions to Problem Sheet I

3

Convexity

Problem Sheet #3; Solutions to Problem Sheet 2

4

Immunization

Problem Sheet #4; Solutions to Problem Sheet 3

5

Profitability measures

First coursework test is given

6

Modern portfolio theory

Problem Sheet #5; Solutions to Problem Sheet 4

7

Value-at-Risk

Assignment I; Problem Sheet #6; Solutions to Problem Sheet 5

8

Bootstrapping

Problem Sheet #7; Solutions to Problem Sheet 6

9

Options: Calls, Puts and Call-Put parity

Assignment I collected. Problem Sheet #8; Solutions to Problem Sheet 7

10

Black-Scholes model

Problem Sheet #9; Solutions to Problem Sheet 8

11

Valuation of financial derivatives

Assignment 2. Problem Sheet 10; Solutions to Problem Sheet 9

12

Practical applications

Problem Sheet #1; Solutions to Problem Sheet I;

Coursework Test 2

13

Revision

Assignment 2 collected and returned. Revision

 

Required Readings

  • Options Futures, and Other Derivatives – John C. Hull 7th Edition 2008
  • Modern Portfolio Theory and Investment Analysis – Edwin J. Elton, Martin J. Gruber, Stephen J. Brown, William N. Goetzmann,  7th Edition 2007