Risk-free Security Research Articles

Portfolio Management of Consumer Industry Based on Index Model

This paper explores the application of the index model in portfolio analysis, highlighting its significance in both macro and security analysis for the optimization of portfolios. Utilizing data spanning from October 2018 to November 2023, the study draws several key conclusions. Firstly, it identifies the optional consumption industry as particularly susceptible to market fluctuations, exhibiting higher sensitivity compared to the daily consumption industry. Secondly, an active portfolio comprising Costco, Walmart, Lululemon, and Under Armour, alongside short positions in risk-free securities, yields the optimal portfolio with a maximized Sharpe ratio. However, the study acknowledges limitations, notably the relatively small sample size and the impact of the COVID-19 pandemic, which introduces extreme risks and potential errors in the analysis. Future research directions include modifying the index model to incorporate volatility adjustments and exploring multi-factor investment models to mitigate errors and enhance portfolio efficiency. This study underscores the importance of continuous refinement and adaptation of analytical frameworks in portfolio management amidst dynamic market conditions.

Determinants of operational efficiency on the financial health of non-life insurance companies in South Africa

This study aimed to determine the effect of operational efficiency on financial health of non-life insurance companies in South Africa. Operational efficiency refers to an insurer’s ability to deliver its services while minimizing costs and maximizing profitability. A descriptive research design was used to achieve the objective of this study. The panel data from 2008–2019 used secondary data sourced from S&P Capital Q and Refinitiv Eikon, well-known databases with readily available data. The population of this study focuses on 32 non-life insurance companies with measurable markets of 57 domestic non-life insurance providers in South Africa. Data were analyzed using Fixed-effect regression, (Random-effect GLS regression, correlation, and the Hausman test. The result reveals that of all the variables, only premium growth correlates significantly (negative correlation) with financial health. This could be a result of a specific investment that resulted in a lower rate than that of a risk-free security. It is also important to note that a negative premium does not always indicate a problem. This can happen due to cancellations of reinsurance, reinsurer closures, paid off reinsurance ahead of time, under- pricing policies, inadequate reserves, high claim frequency, operational inefficiencies, investment losses, inadequate risk assessment, economic downturn, regulatory changes, catastrophic event, and any other events. It is essential for non-life insurance companies to carefully manage their underwriting practices, risk assessment, pricing strategies, and investment portfolios to avoid negative premium situations and maintain financial health.

Optimal consumption, investment and life insurance selection under robust utilities

We study the problem faced by a wage earner with an uncertain lifetime who has access to a Black–Scholes-type financial market consisting of one risk-free security and one risky asset. His preferences relative to consumption, investment and life insurance purchase are described by a robust expected utility. We rewrite this problem in terms of a two-player zero-sum stochastic differential game and we derive the wage earner optimal strategies for a general class of utility functions, studying the case of discounted constant relative risk aversion utility functions with more detail.

Mean-variance portfolio selection with random investment horizon

<p style='text-indent:20px;'>This paper studies a continuous-time securities market where an agent, having a random investment horizon and a targeted terminal mean return, seeks to minimize the variance of a portfolio's return. Two situations are discussed, namely a deterministic time-varying density process and a stochastic density process. In contrast to [<xref ref-type="bibr" rid="b18">18</xref>], the variance of an investment portfolio is no longer minimal when all assets are invested in a risk-free security. Furthermore, the random investment horizon has a material effect on the efficient frontier. This provides some insights into the classical mutual fund theorem.</p>

Optimal consumption, investment and life-insurance purchase under a stochastically fluctuating economy

We study the optimal consumption, investment and life-insurance purchase and selection strategies for a wage-earner with an uncertain lifetime with access to a financial market comprised of one risk-free security and one risky-asset whose prices evolve according to linear diffusions modulated by a continuous-time stochastic process determined by an additional diffusive nonlinear stochastic differential equation. The process modulating the linear diffusions may be regarded as an indicator describing the state of the economy in a given instant of time. Additionally, we allow the Brownian motions driving each of these equations to be correlated. The life-insurance market under consideration herein consists of a fixed number of providers offering pairwise distinct contracts. We use dynamic programming techniques to characterize the solutions to the problem described above for a general family of utility functions, studying the case of discounted constant relative risk aversion utilities with more detail.

Empirical Analysis of the Effects of Macroeconomic Variables on the Equity Market Risk Premium in South Africa

The relationship between the Equity Market Risk Premium (MRP) and macroeconomic variables has been a subject of extensive debate in the finance literature. The MRP is a central component of the main asset pricing models which are used to estimate the cost of equity which is mainly used in investment appraisal, performance measurement and valuation of equity assets. Prior studies have identified a number of macroeconomic variables such as inflation rate, interest rate, foreign exchange rate and political risk as the key macroeconomic variables that determine the size of the MRP. Grounded on previous literatures, the test of the impact of these macroeconomic variables on the MRP is mainly based on data obtained from the developed countries and a few emerging countries, leaving a huge knowledge gap in African based literature. This necessitated the investigation of inflation rate, interest rate, foreign exchange rate and political risk on MRP within the South African context, as these fundamental variables vary across countries. Using secondary time series data for the period 2002 to 2017, a total of 192 observations per variable was used in the study. The model used were tested for possible misspecification errors that could arise from using a secondary time series data and the regression model was fitted using the Ordinary Least Square (OLS) estimator. The results show that inflation rate, interest rate and foreign exchange rate have a negative impact on the MRP whilst political risk has a positive impact on the MRP. Furthermore, the result shows that the inflation rate is the only variable amongst other variable tested that has a significant influence on the MRP for the study period. The study recommends that inflation rate should be monitored and kept within the inflation target to increase investors’ confidence in the security market and also foster economic growth. Keywords: All Share Index, Equity Market Risk Premium, Macroeconomic Variables, Risk-Free Security, South Africa. DOI: 10.7176/RJFA/13-16-03 Publication date: August 31 st 2022

Optimal Investment, Consumption and Life Insurance Problem with Stochastic Environments

Optimal investment, consumption and life insurance problem with stochastic environments for a CRRA wage-earner is solved in this study.  The wage-earner invests in the financial market with one risk-free security, one risky security, receives labor income and has a life insurance policy in the insurance market. A life insurance policy is purchased to hedge the financial wealth for the beneficiary in case of wage earner premature death. The interest rate and the volatility are stochastic. The stochastic interest rate dynamics of risk-free security follow a Ho-Lee model and the risky security follow Heston’s model with stochastic volatility parameter dynamics following a Cox-Ingersoll-Ross (CIR) model. The objective of the wage-earner is to allocate wealth between risky security and risk-free security but also buy a life insurance policy during the investment period to maximize the expected discounted utilities derived from consumption, legacy and terminal wealth over an uncertain lifetime. By applying Bellman's optimality principle, the associated HJB PDE for the value function is established. The power utility function is employed for our analysis to obtain the value function and optimal policies. Finally, numerical examples and simulations are provided.

Optimal Investment and Consumption Problem with Stochastic Environments

Optimal investment and consumption problem for a CRRA investor or agent is solved in this study. An agent invests in the financial market with one risk-free security and one risky security. The stochastic interest rate dynamics of risk-free security follow a Ho-Lee model and the risky security is modeled as Heston’s model with its volatility parameter dynamics following a Cox-Ingersoll-Ross (CIR) model. Interest rates and volatility rates, in reality, are stochastic due to uncertain events such as the Coronavirus disease 2019 (COVID19) pandemic, climate change, etc. Our main goal is to allocate initial wealth x0 between risk-free security and risky security in order to maximize the discounted expected utility of consumption and terminal wealth over a finite horizon. Applying the Dynamic Programming Principle (DPP), the HJB PDE for the value function is established. The power utility function which belongs to the Constant Relative Risk Aversion (CRRA) class is employed for our analysis to obtain the value function and optimal policies. Finally, numerical examples and simulations are provided and discussed.

Sovereign Risk and Financial Risk

This paper examines the relationship between sovereign bond spreads, local economic activity, and global financial risk. We use secondary-market prices of dollar-denominated sovereign securities to construct yield spreads between sovereign bond yields and yields on the appropriately defined default risk-free securities, constructed using zero-coupon U.S. Treasury yields. We use these spreads to construct country-specific sovereign bond spreads for a sample of almost 50 countries over the 1980-2012 period. We then examine the extent to which movements in sovereign spreads are determined by local risk factors, such as fluctuations in exchange rates and local stock market returns, versus global risk factors that arguably proxy for risk-attitudes that prevail in U.S. financial markets. To measure global risk factors we rely on the excess bond premium constructed by Gilchrist and Zakrajsek (2012). The excess bond premium is a measure of distress in U.S. corporate bond markets and comoves closely with conditions in financial markets. According to GZ, the excess bond premium provides a quantitative measure of the risk-attitudes of financial intermediaries. Our results indicate that a substantial portion of the comovement among sovereign spreads can be accounted for by changes in such global risk factors. We also examine the extent to which, during the 2007-09 financial crisis, such global risk factors were related to perceived default risk in the U.S. financial sector. Next, we extend our methodology to construct credit spreads for euro-denominated sovereign bonds for about 40 countries over the 2000-2012 period, and we examine the implications of our empirical pricing framework for comovement among sovereign spreads during the ongoing turmoil in European sovereign debt markets. Lastly, we study the e§ect of various stabilization policy announcements during the recent financial crisis on sovereign bond spreads through the global risk factors. We also compare the impacts of stabilization policy measures during financial crises in the past. Lastly, we construct a general equilibrium model of sovereign debt and default to rationalize the empirical findings. The model features include a risk-averse global investor, optimal default, and endogenous debt dynamics for multiple countries. The sovereign default and bond prices depend on the borrower's economic conditions as well as the lender's risk aversion and riskiness. We quantitatively examine the link between the financial risk that the lender faces and the distribution of sovereign risk.

Bond flotation with exotic commodity collateral

Exotic high tech metals such as rare earth oxides, titanium and nickel wire are increasingly important to semi-conductor, aerospace and high end defence technology R & D and production. As a result—while not market traded and therefore sporadic order dependent and highly volatile—prices of these commodities have been rising on average over the past decade. The metals trading subsidiary of an international group acquired over 6 M metres of nickel wire which at the current market price of about 300 EUR per metre is worth over 1.6 B EUR. The firm wished to raise from 300 M to 1B EUR in the capital markets in order to purchase a variety of these high tech metals to take advantage over the medium term (5–10 years) of generally rising prices. After a brief description of the current state of the exotic high tech metals markets, this paper treats the technical pricing and default risk analysis of an example 350 M EUR 7 year amortized corporate bond issue backed by a nickel wire inventory and subsequent high tech metal trading as collateral. Topics covered include security price modelling with high tech metal collateral, the design of 100% risk free securities with third party derivatives and security pricing and trading methodology. The complex stochastic and Monte Carlo simulation analyses presented are based in part on specially developed modelling of the nickel wire catalogue price and third party price projections for rare earth oxides and titanium. This analysis is based on 10 year (2008–2017) daily market data and supports an optimistic view in that after accounting for all ongoing costs we find a zero default probability for the bond issue—a situation seldom seen to accompany its stipulated 12% internal rate of return.

Investment Attitude of Working Women: A Study of Education Sector in Punjab

Investment is important for improving productivity and increasing the competitiveness of an economy. The present paper is an attempt to explore the factors influencing the investment attitude of women working in the education sector in the Punjab State in India. Even though, general profile of women investors is changing in tune with time, but they are insulating in various spheres of investment such as awareness and preference of investment. Today, the role of women has changed from “Savers to Investors”. Factor Analytical results revealed that women investors prefer to invest in risk free securities. The level of financial knowledge also influences their investment attitude. The present study reveals the factors namely; secure investment avenues, financial literacy, stock market investment and post office schemes, bank deposits, physical assets, risk taking ability and concern for financial matters that are important to women working in education sector.

Performance of Mutual Funds and Mutual Fund Manager in Pakistan

Purpose: This study examined the performance of mutual fund and mutual fund manager in Pakistan during the period of Jul, 2006 to Jun, 2016. The objective is to found the funds’ performance through risk and return and ability to forecast the funds return by mutual fund manager.
 Methodology/Design: The data will be used from the authentic source of SBP publication (State Bank of Pakistan) and MUFAP (Mutual fund association of Pakistan) of 54 mutual funds working in Pakistan. The data will be analyzed by using Statistical tests of Sharpe ratio, Sortino ratio, Treynor measure and Information ratio.
 Results: Results indicated that fund returns are found positive and significant against risk free securities but funds return against the market return and fund manager ability to forecast fund returns is found negative and insignificant the rate of return of an investment made in mutual funds.
 Originality/Value: Islamic funds and Sortino and Information ratio based on our knowledge have not been studied by the previous researchers.

Bond Flotation with Exotic Commodity Collateral

Exotic high tech metals such as rare earth oxides, titanium and nickel wire are increasingly important to semi-conductor, aerospace and high end defence technology R & D and production. As a result – while not market traded and therefore sporadic order dependent and highly volatile – prices of these commodities have been rising on average over the past decade. The metals trading subsidiary of an international group acquired over 6 M metres of nickel wire which at the current market price of about 300 EUR per metre is worth over 1.6 B EUR. The firm wished to raise from 300 M to 1B EUR in the capital markets in order to purchase a variety of these high tech metals to take advantage over the medium term (5 to 10 years) of generally rising prices. After a brief description of the current state of the exotic high tech metalss markets, this paper treats the technical pricing and default risk analysis of an example 350 M EUR 7 year amortized corporate bond issue backed by a nickel wire inventory and subsequent high tech metal trading as collateral. Topics covered include security modelling with high tech metal collateral, the design of 100% risk free securities with third party derivatives and security pricing and trading methodology. The complex stochastic analysis and Monte Carlo simulation analysis presented is based in part on specially developed modelling of the nickel wire catalogue price and third party price projections for rare earth oxides and titanium. The analysis is based on 10 year (2008-2017) daily market data and supports an optimistic view in that after accounting for all ongoing costs we find a zero default probability for the bond issue – a situation seldom seen to accompany its stipulated 12% internal rate of return.

Mean-Variance, Mean-VaR, Mean-CVaR Models for Portfolio Selection With Background Risk

This paper extends Jiang, et al. (2010), Guo, et al. (2018), and others by investigating the impact of background risk on an investor’s portfolio choice in the mean- VaR, mean-CVaR and mean-variance framework, and analyzes the characterizations of the mean-variance boundary and mean-VaR efficient frontier in the presence of background risk. We also consider the case with a risk-free security. Finally, we extend our work to the non-normality situation and examine the economic implications of the mean-VaR/CVaR model.

IMPACT OF THE RISK-FREE RATE ON REQUIRED RETURNS AND ALPHAS OF STOCKS

ABSTRACT The risk-free rate affects both the intercept and the slope of the security market line. It also influences estimates of Jensen's alpha, which is commonly used to measure performance. This is the first study to demonstrate that the risk-free rate has a significant impact on the required returns and alphas of stocks. Using the higher risk-free rate of T-Bonds rather than T-Bills increases betas and required returns of low-beta stocks while reducing betas and required returns of high-beta stocks. It also lowers alphas for high-alpha stocks and raises alphas for low-alpha stocks. These findings reinforce the importance of using T-Bills as the risk-free security in the Capital Asset Pricing Model, since they have less market risk and inflation risk than T-Bonds. Keywords Capital Asset Pricing Model, Required Returns, Risk-free Rate, Alpha, Beta

Legacy Savings Organizations: Beating Deferred Annuity Insurance Benefits by Over 50%; Practical Plan for Funding Extra-Long Retirement

Longevity insurance pays cash benefits to an insured individual who attains a defined age. Thereafter, benefits may continue throughout the insured’s life. For anyone concerned that living too long might become an economic hardship, longevity insurance, at the right price, can make sense. Yet, due to cost, few people purchase it. Longevity insurance’s high price reflects three factors: 1) lingering effects of a 1905 government investigation which pushed the insurance industry to bundle costly, counterproductive features with its longevity products, 2) the corporate structure of the underwriting business which shoulders risk, requires remuneration and itself interposes an additional risk factor (potential insurer default) and, 3) most importantly, inequitable taxation. A legacy savings organization (LSO) is an organizational structure that enables a group of individuals to self-insure far more cost effectively and at lower risk than through a commercial insurer. For instance, through such an organization, a typical 65 year old man, in return for a $100,000 payment placed in risk-free Treasury securities, could expect to receive beginning at age 85 roughly a $50,000 annual, after tax benefit, easily 50% more than most commercial insurers now offer. Today, commercial insurers are engines that turn the principal of one insured into the taxable income of another. An LSO avoids this onerous tax treatment. This report briefly reviews current, commercially available longevity insurance products, describes the construction and delivery of a more attractive alternative through LSO’s and briefly relates the history of similar alternatives.

Investment Property in the Financial Statements of Capital Groups Listed on the Warsaw Stock Exchange

In recent years, investing in property has become very popular. It is related to a significant decrease in interest rates, which has resulted in a decrease in interest rates on bank deposits and risk-free securities. What is more, this kind of investment seems to be less risky than investing in shares or raw materials due to a steady increase in property prices in Poland in the recent years. Investment property owned by an entity conducting business activity must be properly presented in financial statements, which is next reflected in the evaluation of financial position. Recognition, measurement and presentation of investment property in financial statements have been comprehensively prescribed in International Accounting Standard 40 – Investment Property, which was released in December 2003. It was first applied to financial statements prepared for the reporting period starting after January 1, 2005. The standard was revised twice – first in 2008 and then in 2013. The aim of this paper is to describe the recognition, measurement and disclosure of investment property under polish and international accounting regulations as well as to analyze the presentation of such information in financial statements of the largest companies listed on the Warsaw Stock Exchange. The main methods used include the analysis and evaluation of legal acts and subject-related literature as well as the analysis of information disclosed in financial statements of the largest companies listed on the Warsaw Stock Exchange

Optimal life-insurance selection and purchase within a market of several life-insurance providers

We consider the problem faced by a wage-earner with an uncertain lifetime having to reach decisions concerning consumption and life-insurance purchase, while investing his savings in a financial market comprised of one risk-free security and an arbitrary number of risky securities whose prices are determined by diffusive linear stochastic differential equations. We assume that life-insurance is continuously available for the wage-earner to buy from a market composed of a fixed number of life-insurance companies offering pairwise distinct life-insurance contracts. We characterize the optimal consumption, investment and life-insurance selection and purchase strategies for the wage-earner with an uncertain lifetime and whose goal is to maximize the expected utility obtained from his family consumption, from the size of the estate in the event of premature death, and from the size of the estate at the time of retirement. We use dynamic programming techniques to obtain an explicit solution in the case of discounted constant relative risk aversion (CRRA) utility functions.

An empirical analysis of excess interbank liquidity: a case study of Pakistan

We investigate the drivers of excess interbank liquidity in Pakistan, using the Autoregressive Distributed Lag approach on weekly data for December 2005 to July 2011. We find that the financing of the government budget deficit by the central bank and nonbanks leads to persistence in excess liquidity. Moreover, we identify a structural shift in the interbank market in June 2008. Before June 2008, low credit demand was driving the excess liquidity holdings by banks. After June 2008, banks’ precautionary investments in risk-free securities drive excess liquidity holdings. Monetary policy is less effective if banks hold excess liquidity for precautionary reasons.

First-Order Lower Partial Moment Portfolio Theory

The first-order lower partial moment - LPM1 - is the natural measure of the risk of loss for investors with Kőszegi and Rabin (2006) loss aversion. The theory of stock selection and portfolio formation for such investors is LPM1 portfolio theory. The paper shows that in LPM1 portfolio theory, the same portfolio can be both efficient and inefficient. Further, some portfolios are inaccessible to some investors. Returns falling below a loss averse investor's return floor - the target return - are regarded as losses. Two loss averse investors with different target returns can hold exactly the same efficient portfolio, but the risk of that portfolio will be different for each investor. Loss averse investors face, not one efficient frontier, but an uncountable number of efficient frontiers, all of which are convex but only one of which is linear. The portfolios that reside on these frontiers collectively form the portfolio efficient set. Surprisingly, every portfolio in the efficient set contains a combination of the risk-free security and the same risky portfolio. This risky portfolio is defined as the market portfolio. Even more surprising, this portfolio held in common by all loss averse investors is the tangency portfolio of the unique linear efficient frontier. This equivalence between CAPM and LPM1 capital asset pricing occurs because both are special cases of a more general theory.