FM for Actuaries

266 CHAPTER 8
We repeat the above calculations for interest rate of 11%, 15%, 30% and 80%. The
results are summarized as follows:
Table 8.3: Results of Example 8.10
i V A V L S
0.09 2,258.50 2,258.53 −0.03
0.10 2,192.47 2,192.47 0.00
0.11 2,129.05 2,129.08 −0.03
0.15 1,898.95 1,899.65 −0.70
0.30 1,284.61 1,291.97 −7.36
0.80 471.55 499.16 −27.61
For (d), using equation (8.16), the convexity of the assets is
C A = 2×1×44.74 (1.1)−1 +4×3×2,450.83 (1.1) −3 +6×5×500.00 (1.1) −5
(1.1) 2 × 2,192.47
=11.8706,
and the convexity of the liabilities is
C L = 3 × 2 × 1,000 (1.1)−2 +5× 4 × 2,000 (1.1) −4
(1.1) 2 × 2,192.47
= 12.1676.
Under duration matching, when there is an immediate one-time small shift in
interest rate, the surplus (S = V A − V L ) should be preserved (i.e., non-negative).
In Example 8.10, we notice that the values of assets and liabilities are matched
at i = 10% with V A = V L =$2,192.47. When there is an immediate one-time
interest rate change, both asset and liability values move in the same direction.
However, the rate of change of the value in the asset portfolio is slightly lower than
that of the liability portfolio, always resulting in a deficit position. For example,
when interest rate drops from 10% to 9%, the asset and liability values increase
to $2,258.50 and $ 2,258.53, respectively. On the other hand, when interest rate
shifts up to 15%, the asset and liability values decrease to $1,898.95 and $1,899.65,
respectively, with a deficit position of S = −$0.70.
It should be noted that the duration matching strategy is based on the first-order
approximation. To improve the strategy, we may take into account the convexity