Finance Homework Problems

In a paragraph or two, answer the questions as best you can. Feel free to draw on resources other than the textbook.

Life insurance companies are exposed to interest rate risk because they tend to maintain large, long term bond portfolios whose values decline when interest rates rise.

  1. Why do life insurance invest in these types of long-term portfolios that expose them to considerable interest rate risks?
  2. By contrast, property and casualty insurance companies tend to invest much more in shorter term securities. How would you explain the difference in investment styles between life and casualty/property insurance companies?
  3. Give some examples of specific securities that would be more likely found on the asset side of a balance sheet of a life insurance company and those that would be more likely found on the asset side of the balance sheet of a property and casualty company.
  4. What is the reason that all U.S. states have insurance commissions? What do such commissions do?

As a consultant to a state’s underfunded pension fund, you have been asked to search for solutions to prevent underfunding in the future.

  1. One explanation for the underfunding of a defined-benefit plan is that the economy was weak recently, so financial markets were weak, and this caused the underfunding. If so, the underfunding may not be a problem in the future. Do you think this explanation is sufficient and there is no need to search for an alternative explanation and solution? Explain.
  2. One possible solution is for the state’s defined-benefit plan to be converted into a defined-contribution plan. Explain why this may or may not be a viable solution to the problem.
  3. Some state workers prefer a defined-benefit plan because they are afraid that they will make poor investments if they are forced to manage their own funds (as they would if they had a defined-contribution plan). Is that a sufficient reason to force a state to remain on a defined-benefit plan?
  4. Some defined benefit pension have been subject to abuse and some managers have gone to prison for their illegal activities. Can you cite and any particular case where this happened and explain why it did?

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