LEUKOCYTE ADHESION CASCADE
3. LEUKOCYTE ADHESION DEFICIENCIES
Most of Chinese life insurance companies practice the asset and liability management through the liability side. They normally classify the liability according to the different characters, and then choose the proper asset portfolio to match the liability or choose the suitable derivatives. Apparently, this mode needs the perfect financial market and the usage of derivatives. But in China, both requests are defective. Thus in our mind, this mode is not really suit for China life insurance. We will give out our reasons.
a. The durations of financial products are short
The life insurance company invests mainly on the negotiating deposit and the bonds.
The regulation of the deposit is restricting as we mention in the fourth part of this paper, furthermore, the fluidity of the deposit is really bad. Based on the model, we calculate the duration of the bonds in China. See Table 7.
Table 7: Value of Alternative Measures of Duration
Value of alternative measures of duration
term to matu rity
Zero- coupon holding period yield(%
)
D1(The duration we use in this
paper) PV PV*t D2(Dur ation of Fisher and
Weil) PV PV*T 1 1.543 1.00 103.40 103.40 1.00 103.40 103.40 2 1.667 1.95 106.50 208.09 1.95 106.51 208.09 3 2.325 2.86 107.67 308.45 2.86 107.77 308.61 4 2.531 3.74 109.28 408.34 3.73 109.44 408.64 5 2.742 4.57 110.42 504.70 4.57 110.67 505.28 6 2.869 5.37 111.59 599.31 5.36 111.93 600.19 7 3.033 6.14 112.24 688.62 6.12 112.72 690.13 8 3.244 6.86 112.20 770.20 6.84 112.93 772.92 9 3.409 7.56 112.15 848.08 7.53 113.12 852.12 10 3.525 8.23 112.25 923.78 8.19 113.42 929.08 11 3.588 8.87 112.65 999.43 8.82 113.95 1,005.62 12 3.612 9.49 113.32 1,075.66 9.44 114.69 1,082.29 13 3.627 10.09 114.03 1,150.41 10.03 115.44 1,157.37 14 3.641 10.66 114.70 1,222.94 10.59 116.15 1,230.29 15 3.65 11.21 115.38 1,293.97 11.14 116.87 1,301.62 16 3.717 11.73 115.27 1,352.16 11.64 117.02 1,362.46 17 3.799 12.22 114.84 1,403.08 12.12 116.95 1,417.15 18 3.843 12.69 114.84 1,457.51 12.58 117.16 1,473.91 19 3.876 13.15 114.92 1,511.10 13.03 117.42 1,529.51 20 3.917 13.58 114.83 1,559.63 13.45 117.56 1,580.85
And the issued bonds most are less than 5 year maturity (see Figure 10). Combining
the data from Table 7 and Figure10, we get the bond durations of the life insurance companies in China. See the following Table 8:
Table 8: The Bonds Durations of China Life Insurance Companies The Bonds Durations of China Life Insurance Companies Year Proportion of the holding bonds (%)
﹤1 year 1-5 years 5-10 years ﹥10 years
2004 4.6 26.6 50.2 18.6
2005 6.1 19.4 43.6 30.9
Figure 10: Issued Bonds in 2005
Issued bonds in 2005
68%
14%
5%
3%
5% 5%
﹤1 year 1-3 years 3-5 years 5-7 years 7-10 years
﹥10 years
Source: Analysis report of China bond market in 2005
From the table we see that the term structures of bonds in the life insurance companies mostly are less than 10 years although they invest more in the one larger than 10 years in 2005. The duration of bonds in the life insurance companies is about 5-7 years, but the duration of the liability is much longer than the asset which makes a really large duration gap.
b. The limitation of the derivatives
In the life insurance developed countries, most of them use the financial model and
the derivatives to process the asset and liability management. But in China, the usage of derivatives to manage asset and liability is vacuity. In the annual report of the life insurance company, we can see the statement such as our company does not adopt any derivatives. The immature financial market also gives many obstacles to the use of derivatives.
c. The restrict of the internal management
The symptom of the life insurance companies in China is that the investment management far lags the product development. Nearly all the modern products in the developed countries you can find in the insurance market of China, and they spread in an unbelievable speed. However, the design and ratemaking of the product do not consider the factor of asset and liability management. In the other hand, the investment ability of the life insurance company is poor which adds the difficulty to the duration match of asset and liability. All the three reasons we give illustrate that the existing mode of asset and liability management is irrational.
We recommend that not just consider the asset and liability management through the liability side but also the asset side. Meanwhile the design and ratemaking of product are better based on the analysis of investment ability. In this mode, the life insurance companies need to balance both asset and liability sides according to their own situations. Such companies with strong investment ability or with high develop speed, because of the large proportion of investment, they may concentrate on the development of the products which to meet the demand of market. The large scale and weak investment ability companies are better to pay attention to the match of asset and liability. The product development should satisfy the capital situation. The perfect management method is both considering the asset and liability sides. First the company should design the product and the portfolio of the liability which meets the market request, and then choose the optimal asset portfolio to match the liability. If there is any problem to find the optimal asset portfolio, the company should find the
other best asset portfolio as a condition to adjust the liability portfolio.
Figure 11: ALM Process in Life Insurance Company
As in Figure 11, the asset and liability management is a circular process. The life
.2.4 Use of financial derivatives
he financial market in China is still immature and the life insurance companies are
he derivative is A financial instrument whose characteristics and value depend upon
.2.4.1 Options
insurance company can adjust the liability structure though the adjustment of pay forms of the contracts or the expense of surrender. It is necessary to understand the character of each kind of contract, and then the company can form a reasonable product structure which has a good react on the adjustment of the liability.
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not allowed to invest in the foreign financial markets, but the use of financial derivatives is the trend of development. Thus here we recommend some kinds of derivatives for the interest rate risk management.
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the characteristics and value of an underlier, typically a commodity, bond, equity or currency. Examples of derivatives include futures and options. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline.60
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60 http://www.investorwords.com/1421/derivative.html Cash flow of
Liability portfolio
Liability
Cash flow of Asset portfolio Asset dominant
An option is a contract between two parties—buyer and seller—that gives the buyer
here are four basic option strategies: buying a call, writing a call, buying a put, and
Figure 12, if the price of bond underlying the option goes up to B, the buyer can get
he relations between the interest rate and the profit of the buyer can be described as
) If interest rates fall, bond prices rise and the call option buyer has large profit; the the right, but not the obligation, to purchase or sell something at a latter date at a price agreed upon today (Chance 2005). An option to buy something is called call option and to sell something is called put option.
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writing a put. To illustrate how a manager uses them to hedge interest rate risk, we will give the return payoffs in terms of interest rate movements. In the following figures, X is the exercise or strike price to buy the underlying security. C is call premium which the buyer of the call option should pay the writer an upfront fee.
Source: Saunders (2006) p 273
In
the profit of π, which is the difference between B and X minus the call premium (C).
If the bond price goes up to A, the buyer of the call has broken because the profit (A-X) is just equal to the premium payment C.
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following:
(1
Payoff gain
Payoff
Payoff function on a call option
Bond - C
0 π
X A B
Figure 12
Payoff Function for the Buyer of A Call Option on A Bond
more the rates fall, the higher the bond prices go up and the larger the profit on the exercise of the option.
(2) If interest rates rise, bond prices go down and the loss of the buyer of a call option
uying a call option is a strategy to take when the interest rate is expected to fall.
the example of writer of a call option, the payoff function describe as:
) If the interest rates rise and bond prices fall, the profit of the writer will potentially
) If the interest rates fall and bond prices go up, there will be a potential increase of increases. If the interest rates goes up continuously then the bond prices fall below the exercise price X, the call buyer is not obliged to exercise the option. So the loss of the buyer of the call option is just the option premium C.
B
(Saunders 2006)
Source: Saunders (2006) p 724
In
(1
increases. But the buyer of the option is not willing to exercise the option, and then the writer just can sell the option at the exercise price. In this situation, the profit is just equal to the premium, thus the buyer gains and losses nothing.
(2
the loss for the writer. The buyer of the call has motivation to exercise the option
Payoff gain
Payoff
Bond B
X C A
0 Figure 13:
Payoff Function for the Writer of A Call Option on a Bond
-π
which forces the writer to sell the underlying bond. We can see from the Figure, that the loss in this case would be very large which is equal to π.
Writing a call option is a strategy to carry out when the interest rate is anticipated to
o understand the payoff function of the put option, we will start with the Figure 14
the Figure 15, X is the exercise price of the underlying bond. P is the put option
yoff functions of the buyer of the put option are:
er of this put option can increase.
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Payoff gain
Source: Saunders (2006) p 725
Source: Saunders (2006) p 726
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premium.
Thus the pa
(1) If the interest rate rises, the bond price falls to D, the buy
D
X
Payoff Figure 14:
Payoff
Function for the Buyer of A Put Option on the Bond
-P π
0 Bond
Payoff
X
D Payoff
Bond Payoff gain
Payoff loss -πP
Figure 15:
Payoff
Function for the Writer of A Put Option on a Bond
P
0
purchase the bond at D and sell it to the writer of the put at the exercise price X which is higher than D. So the buyer can get the profit πP which deducts the cost of the premium P.
(2) If the interest rate falls to some degree, the bond price will goes up above the
ise, the manager will use the buying of a put option.
he payoff functions of the writer of the put option are:
buyer will not like to exercise
the bond price will falls to D, the option writer
es the interest rate decreases, he can adopt writing a put option.
.2.4.2 Forward contracts
forward contract is an agreement between two parties to buy or sell an asset (which
exercise price X; the buyer of the put option will not exercise the option. The maximum loss of the buyer is P.
If the interest rate is expected to r
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(1) As interest rate falls and the bond price rises, the put
the put option that forces the option writer to buy the underlying bond. The maximum profit of the writer’s profit is just P.
(2) As the interest rate goes up and will suffer a loss πP.
If someone anticipat
But he should take care because the profits are limited but the losses are unlimited.
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can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk, for example currency exposure risk (e.g. forward contracts on USD or EUR) or commodity prices (e.g.
forward contracts on oil)61. One kind of forward contract in hedging the interest rate risk is naïve contract (the hedge of a cash asset on the direct dollar-for dollar basis with a forward or future contract). If we use naïve contact to hedge interest rate risk, any loss or gain on the balance sheet can be offset by a gain or loss on the forward contract. (Saunders 2006) The advantage of the hedge is that if a life insurance company can not predict the correct change of interest rate, it can use the forward
61 http://en.wikipedia.org/wiki/Forward_contract
contract to protect itself against the interest rate risk. So we can say in this case, the life insurance company does not expose to the interest rate risk, it has immunized its assets against the interest rate risk.
7.2.4.3 Future contracts
he future contract is a legally binding arrangement where one party commits to
.2.4.4 Swaps
contract which two parties agree to exchange cash flows is called swap (Don 2005).
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buying an asset from another party on a specified date in the future, but at a price agreed previously. The counterparty is obliged to sell the asset at the agreed price and on the agreed date. Because the price is agreed at the outset the seller (buyer) is protected from a fall (rise) in the price of the underlying asset in the intervening time period. Initially developed to protect agricultural producers from unforeseen market fluctuations - hedging.62 A future contract is similar to a forward contract. The difference relates to the price, which in a forward contract is fixed over the life of the contract, but in the future contract is market to market daily. This means the contract’s price adjusted each day as the futures price for the future changes. (Saunders 2006) One kind of classification of the future contract is contained the routine hedging and selective hedging. The routine hedging is a contract seeks to hedge all interest rate risk exposure. The selective hedging is only partially hedging the gap or individual assets or liabilities. The effect of these contracts we can illustrate in the following Figure 16.
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The swaps are classified as interest rate swaps, currency swaps and equity swaps, etc.
The usage of swap we can understand though an example. If a company receives cash from one investment but it prefers to invest in the other project which the cash flow is different. The company will contact a swap dealer; a firm operates in the
62 http://www.lse.co.uk/financeglossary.asp?searchTerm=&iArticleID=2050&definition=future_contract
over-the-counter market, who takes the opposite side of the transaction. Thus the company and the dealer swap cash flow streams. One party may gain the expense of the other which depends on what later happens to the prices or the interest rate.
Figure 16: The Effects of Hedging on Risk and Expected Return
. Shortcomings and contributions
ur thesis is concerned about the interest rate risk management of Chinese life
Expected
Source: Saunders 2006, p 693
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insurance companies. Although many domestic papers research in such field and they also point out that the interest rate risk of the life insurance companies comes from the duration gap, they do not give out the data to illustrate such problem. In our paper, we calculate the duration of the bonds which are invested by the asset of life insurance companies. Then we introduce the asset and liability management method to be the instrument as the tool of interest rate risk management. The ALM method we introduced is relevant with the immunization we mentioned. We try to combine these two methods to set an efficient way to deal with the interest rate risk. Also we summarize the emerging market of Chinese insurance industry which no paper or research mentioned. Furthermore, we try to consider the insurance contract as an
Return
Risk Minimum
Risk portfolio Fully
Unhedged Selectively hedged
Overhedged
0
option package which is still vacant in the domestic researches in China.
However, because we write the thesis abroad, much information and data we can not
Conclusions
this section we will get a conclusion of our paper and suggest for the further
he major model we use to measure the interest rate risk is the duration model. After
hen we give a detail discussion about the emerging Chinese insurance market. From acquire directly and distinctly. Such inconveniences give us many difficulties to the data collection. And some data of the life insurance companies is un-transparent or not allowed to open to public which bring many troubles for the statistics. Thus maybe there are some mistakes on some detail data in our statistics.
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research. As we know, there are many kinds of risks faced by the life insurance such as the credit risk, interest rate risk, and foreign exchange risk and so on. The paper is a research about the interest rate risk of the life insurance companies. We first describe the general situation about the history of the insurance industry of China and the evolvement of the insurance products.
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we establish the model and list our hypothesis, we analysis the shortages of the duration model and introduce the modified duration, efficient duration and convexity to modify the shortage of the original duration model. Also, we try to consider the life insurance contracts as the option packages which are affected by the change of interest rate. An option gives the policyholder more rights to maximum his benefits and gives the life insurance company more risks while the financial elements change.
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the economic, political and legal views, we describe the status of the emerging insurance market and analysis why it can develop so fast. To explain how fast it develops, we use the data from premium, saving, market penetration, etc. Of course, we do not just see the progress but also the challenges. We aware that even the
insurance industry develops so fast, the other factors of the financial systems are still lagging of it which may disturb its rapid development. Meanwhile, the unbalance of the development will result in many potential problems which called bubble.
Based on the financial environment that the life insurance companies faced, we
uggestions for the further research
would be interesting to research in-depth the life insurance contract as an option
cknowledgement
e would like to thank our advisor, Anders Grosen, for the suggestions and the recommend some instruments for the interest risk management. From the data observed we know that the duration gap between asset and liability of the life insurance companies is more than 10 years. Such large duration gap makes the company exposes in the serious interest rate risk especially the interest rate fell dramatically in the past 10 years of China. Now China will adopt the floating interest rate system which will bring on the life insurance company more interest rate risk. To control the interest rate risk we use the immunization theory on the asset and liability management. We concentrate the use of immunizing the duration gap. But we do not recommend to control the risk through adjust the structure of the asset or liability because it is cost. If possible, it is better to adopt derivatives to evade the interest rate risk. So even the financial market of China is immature but we also introduce some kinds of derivatives which we hope can be use in the future.
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package. Combining this theory to the usage of derivatives to manage the interest rate risk may be more attractive to the manager of insurance companies. And it is better can be calculate the abatement of cost by using the derivatives and the profit the company can gain.
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guidance in the whole progress. Also we should thank Frank Peterson who makes us