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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

After 2021, inflation in many countries rose partly because of supply-chain bottlenecks and energy price spikes following the Russia-Ukraine war. Central banks responded with sharp policy rate increases. For a life insurer holding a large portfolio of fixed-rate government bonds, what is the most direct immediate effect of this rise in yields?

The market value of the insurer's fixed-rate bonds falls. Bond prices move inversely to yields, and existing coupons and redemption amounts are fixed, so discounting them at higher market yields gives a lower present value.

  1. AThe market value of the bond holdings fallsCorrect
  2. BThe market value of the bond holdings rises
  3. CThe coupon payments on existing bonds rise automatically
  4. DThe bonds' redemption values fall
  5. The bonds' credit risk becomes zero

Explanation

Bond prices move inversely to yields. Existing fixed-rate bonds have fixed coupons and fixed redemption values, so when market yields rise their present value falls, creating unrealised losses for the holder.

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