Company A is an insurance company, which has products such as group insurances, health insurances, auto insurances, etc. In addition, the company invests in a portfolio with six equities: Kodak($150,000), 

McDonald's($300,000), 

Intel($350,000),

 Merck($500,000), 

Wal-Mart($600,000) 

and Microsoft($560,000). 

Assume these six equities are uncorrelated and their volatilities are 3, 9, 8, 3, 12 and 6 percent, respectively. Company A has a total asset value of $100m, and company B has a total asset value of $200m. The expected rate of growth of A's asset value is 10% per annum with volatility 25% per annum. For B, the expected rate of growth is 5% per annum with volatility 10% per annum. The returns of them are linked by a generalized Clayton copula which is given by (10.174) in FERM (page 212) with alpha_1=1 and beta=2, if the total borrowing for company A and B consist of fixed borrowing of $50m and $100m, respectively, in each case repayable in exactly two years' time. Moreover, Company B is now rated as AA by Standard and Poor's. 

 1. How should company A build its risk management framework?

 

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Table 14.9 Standard & Poor's Average One-Year Global Migration Rates, 1981-2009 (%) Year-end Rating BB AAA AA A BBB 88.21 7.73 0.52 0.06 0.08 0.03 0.06 0.00 0.56 86.60 8.10 0.55 0.06 0.09 0.04 1.95 87.05 5.47 0.40 0.16 0.02 0.02 0.02 0.08 0.26 0.97 0.01 0.14 3.76 84.16 4.13 0.70 0.16 0.02 0.05 0.18 5.17 75.52 7.48 0.79 0.00 0.04 0.15 0.24 5.43 72.73 4.65 4.93 CCC-C 0.00 0.00 0.21 0.31 0.88 11.28 44.98 27.98 AAA AA Initial A Rating BBB BB B B CCC-C Default Unrated 3.31 4.00 4.83 6.68 9.82 11.83 14.37 Standard & Poor's: $2009 Annual Global Corporate Default Study and Rating Transitions, Standard & Poor's Global Fixed Income Research, (2010) Table 14.9 Standard & Poor's Average One-Year Global Migration Rates, 1981-2009 (%) Year-end Rating BB AAA AA A BBB 88.21 7.73 0.52 0.06 0.08 0.03 0.06 0.00 0.56 86.60 8.10 0.55 0.06 0.09 0.04 1.95 87.05 5.47 0.40 0.16 0.02 0.02 0.02 0.08 0.26 0.97 0.01 0.14 3.76 84.16 4.13 0.70 0.16 0.02 0.05 0.18 5.17 75.52 7.48 0.79 0.00 0.04 0.15 0.24 5.43 72.73 4.65 4.93 CCC-C 0.00 0.00 0.21 0.31 0.88 11.28 44.98 27.98 AAA AA Initial A Rating BBB BB B B CCC-C Default Unrated 3.31 4.00 4.83 6.68 9.82 11.83 14.37 Standard & Poor's: $2009 Annual Global Corporate Default Study and Rating Transitions, Standard & Poor's Global Fixed Income Research, (2010)

Answer rating: 100% (QA)

Company A should build its risk management framework by considering various aspects of its operations including its insurance products investment portfolio and borrowing Here are some key components t... View the full answer