Fiona Corcoran is responsible for meeting distri- butions for EEM Health and Lif

Question

Fiona Corcoran is responsible for meeting distri- butions for EEM Health and Life Insurance Conm pany. An actuary, Robert Bjornsund, has forecasted that a specific policy will require $210,000 arter ten years. Current interest rates are 8 percent, and RPM Restoration equipment trust certificates (i.e., collateralized bonds) are available for possible in vestment. Their terms are Bond A: zero percent coupon with maturity in 10 years, Bond B: 8 percent coupon with maturity in 10 years Bond C: 8 percent coupon with maturity in 18 years. Bjornsund, who has not been trained in invest- ments, is dubious that the three alternatives wil meet the required cash in a timely fashion and asks several questions.

Explanation / Answer

5) Yes the prices of bond may change due to change in market interest rates. If interest rates rise, the value of the bonds will fall anc they can be bought cheaply. On the other hand if the interest rates fall, the value of bonds will rise and a larger payout will be required for purchasing them.

6) If interest rates rise annd remain at 10 percent the bonds will cost less to buy and the bond that fulfills the cash flow needs i.e. bond A will still meet the objective of cash flow need. The only difference will be the cost of bond that will change.

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