Longevity Bond

[Laurelinda]

I had a nightmare last night about the longevity bond question on the exam. Did anybody nail the calculation on that one? I don't even remember what it was asking for--it went right over my head and I turned the page. :tup:

[namssa]

I can't remember what it asked us to calculate. Can you refresh my memory?

[Laurelinda]

Something like a "maximum bid price for the bond" if the pension plan was willing to spend 3% a year in hedging costs. We were given a bunch of central death rates.

[namssa]

Oh, yeah...

I just calculated the pv of the bond coupons discounted at the rf rate + the hedging cost and decremented the coupons for survivorship. Hopefully, that's what they were looking for.

[namssa]

Make that discounted at the interest rate - the hedging cost.

[TiderInsider]

You had to calculate the PV of the bond given they only wanted to give up 30 bps (or something like that). They gave you the survivorship index and told the payoff was linked to that...there were also some simple list questions about what the risks are in mortalilty linked bonds and why governments and hedge funds would be interested in the bonds.

[TiderInsider]

Too slow...namass, I added the hedge cost in the first time...then I realized that that method didn't make since, so I went back and redid the calculation.

[namssa]

Too slow...namass, I added the hedge cost in the first time...then I realized that that method didn't make since, so I went back and redid the calculation.

So, I was trying to describe that I lowered the discount rate, and thus the yield for the bond by 30bps.

Are you saying that you don't think this makes sense? If so, what do you think that they intended for the solution to be?

[TiderInsider]

I think we're saying the same thing...I had it backwards when I first worked the problem.

Higher hedge budget ---> willingness to spend more for bond ---> higher priced bond ---> lower yield...if you follow this logic it means that you must subtract the 30bps from the treasury...for some reason I added it to the treasury yield...thankfully I figured it out in the end.

[namssa]

:toast:I think we're saying the same thing...I had it backwards when I first worked the problem.

Higher hedge budget ---> willingness to spend more for bond ---> higher priced bond ---> lower yield...if you follow this logic it means that you must subtract the 30bps from the treasury...for some reason I added it to the treasury yield...thankfully I figured it out in the end.

[Laurelinda]

I so failed this exam. I didn't even know where to start on that problem.

Glad someone else did, though! :tup:

[Mr. BoH]

Higher hedge budget ---> willingness to spend more for bond ---> higher priced bond ---> lower yield...if you follow this logic it means that you must subtract the 30bps from the treasury...for some reason I added it to the treasury yield...thankfully I figured it out in the end.

Oh crap. Now that you're saying this, I might have done the hedging cost in the wrong direction also. Crap. I actually thought I got this one right.