Chapter Six Insurance companies sell insurance policies for a premium Two sources of income: underwriting and investment

Life insurance pays the beneficiary of the life insurance policy in the event of the death of the insured Health insurance pays the insured all or a portion of the medical treatment of the insured Property and casualty insures the risk of damage to various types of property Liability insures against the risk of litigation, or the risk of lawsuits against the insured due to actions by the insured or others Disability insures against the inability of employed persons to earn an income own occ disability insurance is written for professionals in white collar jobs any occ for blue collar workers guaranteed renewable is a term where the issuer has to sustain the policy for a specified period of time but can change the premium rates for the entire class noncancellable and guaranteed renewable whereby the issuer has no right to make any changes in any policy in the specified period Long-term care provides custodial care for aged no longer able to take care of themselves Structured settlements are fixed, guaranteed periodic payments over a long period of time Guaranteed investment contract is a pure investment product where a life insurance company agrees, for a single premium, to pay the principal amount and a predetermined annual crediting rate over the life of the investment (all of which is paid at maturity) Annuity is not taxable if not withdrawn from annuity product; expressed as a mutual fund in an insurance wrapper Monoline insurers guarantee the timely payment of the bond principal and interest when a bond insurer defaults on these payments (traditionally municipal bonds); monoline insurers have and must have the AAA rating Companies that provide both types of insurances (life, health, property, casualty) are called multiline insurance companies Health insurance is backing away from life insurance due to fed. reg. of the health industry Life insurance focus on investment products Disability insurance is now sold primarily by pure disability companies Regulation at state levels for insurance industry due to McCarran-Ferguson Act of 1945 Model laws and regulations developed by National Assoc. of Insurance Commissioners (NAIC) State statutory surplus requirements are called statutory surplus

Bankassurance - commercial bank distribution of insurance company products; home office/investment/sales force Stock insurance company is owned by independent shareholders that care about the performance of their shares; insurance policies are the products of the company Mutual insurance company have no stock or external owners; the policyholders are also their owners who care solely about the performance on their insurance policies (companys ability to pay) Mutual hold company is a hybrid between a mutual and stock insurance company circa 1996 Term insurance policies pay off only on death, no investment benefits so premiums are substantially lower than those on whole life Cash value life insurance is broken into: whole life insurance - not subject to tax, can be withdrawn and can be borrowed against by the owner of the policy guaranteed cash value life insurance - provides cash value based on a minimum dividend paid on the policy; can be participating (dividend paid on the policy is based on realized acturial exp. of the company) or nonparticipating (min. div. and the min. cash value on the policy are guaranteed amounts) variable life insurance - typically has common stock options; allow the policy owner to, within limits, allocate their premium payments to and among separate investment accounts maintained by the insurance company flexible premium policies-universal life insurance - cash value fund to which the investment income is credited and from which the cost of term insurance for the insured is debited variable universal life insurance - combine the features of variable life and universal life policies Survivorship (Second to Die) Insurance added dimension of the whole life policies is that two people who are jointly insured and the policy pays the death benefit when the second person dies (survivorship) General Account and Separate Account Products separate account products - insurance products receive no guarantee from the insurance companys general account and is not based on performance general account products - products used to support the guaranteed performance of their general account products to the extent of their solvency (most written in mutual companies) Differences between policies include: the expected time at which the average payment will be made by the insurance company, the statistical or actuarial accuracy of estimates, other factors Changes in the insurance industry: deregulation of the financial system (Gramm-Leach-Bliley Act allow conglomeration of commercial, investment, and insurance [banks] companies), internationalization of the insurance industry, demutualization (mutual => stocks) Individual Retirement Accounts

401(k) plans are provided by an employer whereby an employee may elect to contribute pretax dollars to a qualified tax-deferred retirement plan Roth 401(k) traditional IRA Roth IRA rollover IRA employer sponsored IRA included Simplified Employee Pension (SEP) plans and Savings Incentives Matching Plan for Employee (SIMPLE) Chapter Seven Mutual and Exchange Traded Funds Mutual funds are sold through the company and shares are sold at Net Asset Value NAV per share = Market value of portfolio - liabilities / number of shares outstanding Determined once per day at the end of the day Open end fund - open in the sense that shares may be redeemed or created everyday more investors, more demand > more shares less investors, less demand > fewer shares redeemed or purchase at the end of the day when NAV is calculated Closed end fund - fixed number of shares, determined at the beginning, can only be traded once, buy in or sell out only by trading with other investors trade at any time, below or above NAV, like stock Load - fee (percentage) charged to cover selling expenses of the fund front end (class a), back end (class b), level (class c) 12-b expenses are also known as cover distribution costs and are regulated to <1% per year Index funds are designed to track an equity index: S&P 500 and NASDAQ Exchange Trade Funds designed to capture the advantages of both closed-end and open-end funds, trade through the day on an exchange like a closed end fund and historically have tracked an index characteristics of open-end funds: trades at NAV easy to buy in or cash out new shares harder to manage have to enter/exit at close of day NAV characteristic of close-end funds: trades on an exchange all day available to short or option can trade above or below NAV

Sales Charge sales force occurs via an intermediary agent direct distribution takes place without an intermediary Investment companies: provide risk reduction via diversification, lower costs of contracting and processing information, professional portfolio management, liquidity, variety, and payment mechanism Regulation of funds: 1) Reporting after taxes 2) More complete reporting fee 3) More accurate and consistent reporting of investment performance 4) Requiring fund investment practices to be more consistent with the name of a fund to more accurately reflect their investment objectives 5) Disclosing portfolio practices such as window dressing 6) Various rules to increase the effectiveness of independent fund boards Structure of a Fund: board of directors, mutual fund, investment advisor, distributor, other service providers Board of directors is to represent the fund shareholders External advisers are called subadvisers, and they are used to develop a fund in an area in which the fund family has no expertise, to improve performance, to increase assets under management, to obtain an attractive manager at a reasonable cost Distribution channels Supermarkets - offer funds from a number of mutual fund families Wrap programs - managed accounts, typically like mutual funds or ETFs wrapped in a service package, the service provided is often asset allocation counsel, or the advice on the mix of managed funds or ETFs Fee-based financial advisors - charge fees are typically a percentage of assets under management or alternatively an hourly fee or a fixed retainer Variable annuities Authorized participants (AP), or arbitragers, are the only investors who may create or redeem shares of an ETF with the ETF sponsor and then only in large specified quantities called creation/redemption units (50,000 to 100,000 ETF shares) ETFs require a company to sponsor them, the sponsor must develop the index, retain the APs, provide seed capital to initiate the ETF Chapter Nine Moneyness is the degree to which an asset can be used as a medium of exchange

Divisibility relates to the min. size in which a financial asset can be liquidated and exchanged for money Reversibility is the cost of investing in a financial asset and then getting back to cash (aka turnaround or round-trip cost) Spreads vary due to risk-variability of price and thickness of market Cash flow Term to maturity is the length of time until liquidation Convertibility is the ability to convert one assets into another Currency is the foreign exchange value or foreign currency denomination of an asset Liquidity is the cost of selling an asset immediately against the cost of a timely search for an acceptable price Return predictability is a basic property of financial assets, in that it is a major determinant of value Complexity is the characteristic of being a combination of two or more assets Tax Status Appropriate Discount Rate r = RR + IP + DP + MP + LP + EP real rate of interest + inflation premium + default risk premium + maturity premium + liquidity premium + exchange rate risk premium Lower the coupon the greater the % of price sensitivity due to the reinvestment factor Greatest price sensitivity is associated with coupon bonds Duration: measure of price sensitivity [(price if yield is decreased - price if yield is increased) / (initial price (higher yield - lower yield))] * 100 Durations effect of price changes: -D (change in yield) x 100 Macaulay Duration is a weighted average term to maturity of the components of a bonds cash flows, in which the time of receipt of each payment is weighted by the present value of the component Chapter 10 Loanable Funds Theory -> Fisher: supply and demand between firms, govts, and households Liquidity Preference Theory -> Keynes: supply and demand between liquidity effect: when more money supplied is more than that demanded, individuals will buy bonds, increasing prices and lowering yields income effect: increased investment generates more income and desire to hold money, creating upward pressure on yields On the run treasuries are newly issued bonds Off the run treasuries are bonds that were issued in the past the base interest rate is the rate for the on the run treasury

Risk free bonds: US Treasuries, risk free rate of interest is determined by the prices of US Treasury bonds Risky bonds: corporations also issue bonds, these carry the risk that the company will not be able to pay if the business is poor Investment grade bonds: AAA, AA, A, BBB Junk bonds: BB, B, CCC, CC, C Spread is the difference btwn. rates because of risk, maturity, taxes, or liquidity (Treasury is the basis)