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Paper ID 00233

THE UNIVERSITY OF NEW SOUTH WALES

SEMESTER 2 2012

ACTL5303 / ACTL4303: ASSET-LIABILITY MANAGEMENT

FINAL EXAMINATION

1) TIME ALLOWED - 2 HOURS.

2) READING TIME - 10 MINUTES

3) THIS EXAMINATION PAPER HAS 6 PAGES

4) TOTAL NUMBER OF QUESTIONS 4

5) TOTAL MARKS AVAILABLE - 70

6) ALL QUESTIONS ARE NOT OF EQUAL VALUE. MARKS AVAILABLE FOR EACH QUESTION
ARE SHOWN IN THE EXAMINATION PAPER

7) ALL ANSWERS MUST BE WRITTEN IN INK. EXCEPT WHERE THEY ARE EXPRESSLY
REQUIRED, PENCILS MAY BE USED ONLY FOR DRAWING, SKETCHING OR GRAPHICAL
WORK

8) THE PAPER MAY BE RETAINED BY THE CANDIDATE.

9) CANDIDATES MAY BRING IN THEIR OWN UNSW APPROVED CALCULATOR

1
Question 1: [15 marks]
a. What different organizations need their borrowings to be rated by rating agencies?
[5 Marks]

b. What factors do rating agencies take into account when assigning ratings? [5 Marks]

c. Outline how the rating agencies have been criticised for conflicts of interest and
contributing to perverse pro-cyclical capital requirements. [5 Marks]

2
Question 2: [17 marks]

An Australian listed property company is raising funds for the acquisition of a large retail
park in the United Kingdom, which will make up a significant proportion of its total assets.

a. Discuss what instruments or methods could it use to fund the acquisition? [6 Marks]

b. Which investors might be approached to take large stakes? [4 marks]

c. How would its management and board determine the ideal gearing ratio subsequent
to the capital raising? [5 marks]

d. Say what return you think Australian investors would require in the current
environment for two of the instruments you have mentioned in (a) above? [2 marks]

3
Question 3: [22 marks]

The Australian government set up the Future Fund with a mandate to make long term
investments to provide for the deficit in Commonwealth government defined benefit
superannuation funds. In 2006, the Treasurer gave the Future Fund the following
instructions to determine its benchmark return:

"Benchmark return

The Board is to adopt an average return of at least the Consumer Price Index (CPI) + 4.5 to
5.5 per cent per annum over the long term as the benchmark return on the Fund ....

In targeting the benchmark return, the Board must determine an acceptable but not
excessive level of risk for the Fund measured in terms such as the probability of losses in a
particular year."

a) What are the advantages and disadvantages of specifying a benchmark of this type?
[5 marks]

4
Question 3 continued:
The following is taken from the Future Fund 2011 annual report:

"The board of the Future Fund has adopted a Long Term Strategic Asset Allocation (LTSAA),
and a shorter-term Target Asset Allocation ....

While the LTSAA provides a broad framework for the portfolio which might, on average, be
held over time, a combination of assets which reflects a judgement about the economic and
market environment, and hence the expected prospective reward for taking on risk in
different asset sectors, is set from time to time. We refer to this as the Target Asset
Allocation .

... the skill of the management team in implementing the Board's strategy, by producing a
return in excess of the policy portfolio implied by the Target Asset Allocation, is measured
and rewarded. A series of benchmarks which approximate the characteristics of each
category of the Target Asset Allocation has been developed, as set out in the following."

(The following table has been abbreviated)

Category/sector Policy benchmark representative index

Equities

Australian equities ASX 200 (ex A-REITS) Accumulation Index

Global developed markets

MSCI World ex-Australia (currency hedged)
equities (ex Australia)

Private equity Cambridge Associates Private Equity Universe

Tangible Assets CPI+ 5% p.a.

50% Barclays Capital Global Aggregate [ex Sovereign]

Debt Index (duration and currency hedged) and 50% Barclays
High Yield Index (duration and currency hedged)

Cash UBS Bank Bill Index

b) Discuss the reasons for adopting different strategic and tactical asset allocations.
[6 marks]

c) Comment on the benchmarks used in the table, discussing how a portfolio might
deviate from the benchmark and how the benchmark might systematically
understate the returns from a passive portfolio. [8 marks]

d) What are the agency risks in this arrangement? [3 marks]

5
Question 4: [16 marks]
A global actuarial consultant has developed an interest rate model with the following
components:

Where rand / refer to short and long term interest rates respectively, while p refers to the
level of inflation. Subscript u refers to "normative levels" of the respective rates, while
subscript t refers to the current level. The/; are "vector functions that depend upon various
economic factors up to time t."

a) Explain briefly the economic rationale for (or intuitions behind) this model. [7 marks]

b) What uses would this model have? [5 marks]

c) In order to be completely realistic, describe in broad terms the constraints or

additional factors you would add to this model. [4 marks]

END OF PAPER