UNSW Risk and Actuarial Studies

ACTL1101 Introduction to Actuarial Studies

GROUP ASSIGNMENT
Session 2, 2014
The Assignment consists of 2 parts Part (a) and Part (b).
Marks total 100 and the Assignment counts 20% towards nal assessment.
Part (a) is due Week 6 Friday 5 September 2014 at 11.55am. Part (a) is worth 40 marks.
Part (b) is due Week 10 Friday 10 October 2014 at 11.55am. Part (b) is worth 60 marks.
In Week 1 you will be allocated to groups of four (4) students based on your tutorial.
This will be advised through Moodle. You will be able to revise these allocations at your rst tutorial.
In some cases the group numbers may vary because of enrolment changes.
You will work together as a team in the assignment.
For each part you will be assessed on:
Critical thinking and problem solving (60% of total marks for each part)
Written communication (40% of total marks for each part)
1 Assignment
You will undertake a group assignment with two parts to develop your application of the course mate-
rial. You will work informally as part of an allocated group. The group task will require you to work
with the others in the group to use spreadsheets to solve applied problems and to write the results in
a report format. Each group will appoint a group leader who will be responsible for allocating tasks
and ensuring assignment results are submitted on time. Each Part of the assignment involves two
tasks. You will need to allocate the tasks to the group members and establish a process for working
together, determining who will carry out any analysis, who will draft the reports, who will review
the reports and who will submit the reports on Turnitin and who will conrm that tasks are being
completed.
The assignment Part (a) is due Week 6 Friday 5 September 2014 at 11.55am and Part (b) Due
Week 10 Friday 10 October 2014 at 11.55am. Assignments are to be submitted online via Turnitin.
Information regarding this will be made available on the Moodle course web site.
2 Learning outcomes
This assignment aims at developing the course learning outcomes associated with the course aims,
as well as all the ASB Program Goals but in particular 2. Critical thinking and problem solving
- You should be able to identify and research issues in business situations, analyse the issues, and
propose appropriate and well-justied solutions. and 3.a Written communication - Prepare writ-
ten documents that are clear and concise, using appropriate style and presentation for the intended
audience, purpose and context. You are expected to demonstrate your ability to apply foundation
actuarial techniques to problem solving, to interpret your analysis and to communicate your results
to the intended audience.
Marks will be awarded for neatness, quality and clarity of presentation.
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Assignment Part (a)
Task 1 (25 Marks).
Your group has been retained by a Casino to assist with the design and analysis of some of its games.
A new gambling game is to be introduced by the Casino.
In this game players make bets with payments based on the spin of a wheel with three dierent
outcomes - WINNER, TRY AGAIN and BAD LUCK.
The proportion of WINNER outcomes is p, the proportion of TRY AGAIN outcomes is q and the
remainder are BAD LUCK outcomes (proportion 1 p q).
If the wheel lands on WINNER then you will receive A dollars on the rst occasion, A
2
dollars on the
second occasion and in general A
n
on the n
th
occasion.
If the wheel lands on TRY AGAIN, you get to - TRY AGAIN!
If the wheel lands on BAD LUCK then the game is over.
There are two forms of the game being considered.
In the rst form of the game you only continue playing if you get TRY AGAIN, otherwise you win
zero or A
n
where n is the rst time you get the WINNER outcome and the game ceases as soon as
you get a WINNER spin. In the second form of the game if you spin WINNER on the n
th
occasion
then you receive A
n
but continue playing.
The Casino wants to know how to determine A, p, and q for a single dollar bet in order to ensure
that the game provides the Casino a favorable margin. They want to know this for both forms of the
game and want you to consider which form may be a better alternative based on time spent playing
the game.
Draft a report for the Casino. Your report should give your analysis and formulae in an Appendix
and should illustrate your results using appropriate graphics, charts or tables as well as being concisely
written. Your report should be a maximum of 1 A4 page, 12 point font and the Appendix a maximum
of 1 A4 page.
Task 2 (15 Marks).
In another game at the Casino, a player play a series of games against the house. The player wins
the series if they win two consecutive games in a row before the house has won more games than the
player. The house wins the series if it wins more games than the player before the player wins two
consecutive games. Only the rst game can be drawn and this has probability of occurring of
1
2
. The
probability that player will win the rst game is set at
1
3
.
The Casino wants the game to be designed so that at the start of the game the chances of either
the player or the house winning the series are equal. After the rst game, the chance that player will
win a game is the same for each game.
The Casino has asked your group to determine the chance that the player will win any single game
after the rst so that the the chances of either the player or the house winning the series are equal.
They also want to know how the odds of winning the series vary with changes to the chance of the
player winning any single game after the rst.
Draft a response to the Casino. Your response should be a maximum of 2 A4 pages, 12 point font
and be in the form of a technical document including any necessary formulae and logic.
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Assignment Part (b)
Task 3 (40 Marks)
Your group has been approached by a demographic research company with sophisticated statistical
analysts. They want to know something about mortality rates for Australian males aged 50 to 70. To
do this you have been asked to carry out a t of a Gompertz hazard rate to Australian mortality rates
Australian Life Table 1990-1992 Males (ALT9092M) and to provide a report with all the technical
details of how you do this as well as the nal results. You have been discussing this issue with an
experienced actuary who has suggested the following.
1. For the Gompertz mortality rate (x) = Bc
x
B > 0, c > 1, x 0 an expression for
g(x, B, c) = log (log (1 q
x
)) can be written in the linear form g (x, , ) = + x where
and are constants that do not depend on x.
2. By plotting f(q
x
) = log (log (1 q
x
)) against x for ages 50 to 70 inclusive the linearity of the
above relationship can be checked.
3. Fitting a Gompertz hazard rate over ages 50 to 70 inclusive can be done by selecting values for
the parameters and that minimise
h(, ) =
x=70

x=50
[f(q
x
) { + x}]
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(a) This can be done by dierentiating h(, ) with respect to and and hence deriving
expressions for and that minimise h(, )
(b) Once numerical values for the expressions for and are determined, the corresponding
values for B and c are determined using the earlier relationships.
The demographic research company has previously tried to t the values of B and c for Gompertz
mortality rate (x) = Bc
x
B > 0, c > 1, x 0 by directly minimising
x=70

x=50
[f(q
x
) g(x, B, c)]
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numerically using Excel. To do this in Excel they set some initial values for B and c in two cells then
determine two columns of values of f(q
x
) and g(x, B, c) by age. These two columns are dierenced
and squared. A cell with the sum of the squared dierences is then minimised using the Tools, Solver
in Excel by varying the cells containing B and c. They placed constraints on the values for B (> 0)and
c (> 1) .
However they are concerned about the accuracy of the results.
Prepare a draft of your report. Your report should be a maximum of 2 (two) A4 pages, 12 point
font and be in the form of a technical document.
Task 4 (20 Marks)
Your group has been approached by an investor who has loaned money to a company that has bor-
rowed money by issuing a loan security to investors under which it will pay the investors 5% p.a. as an
interest payment at the end of each year for 5 years and $1,000 on maturity in 5 years. The company
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has recently been in nancial trouble and some nancial analysts have expressed concern that the com-
pany may default on the loan and not pay either some of the interest payments or some of the principal.
You have been asked to apply actuarial methods to assess the default risk on the loan payments
in the same way as actuaries do for the death of a life in life insurance.
You are considering a survival function for this company as
s(t) = exp(0.03t)
where t is the time from issue in years.
You have been advised that when default occurs the investor will immediately receive 60% of the
present value of the outstanding payments determined at the date of default calculated at 6% p.a.
interest and that default is only found out about at the payment date when the company does not
make the interest payment then due.
If default occurs on a payment date then the payment then due becomes an outstanding payment to
be included in the present value used for outstanding payments on default. Otherwise the investor
receives the payment then due in full.
The investor would like you to assess the value of the loan allowing for default and to illustrate
how sensitive the value is to changes in the survival probability of the company and interest rates.
To do this you decide to develop a life table for the bond payments using the suggested survival
function showing survival probabilities for each year and the probability of default (death) in each
year and use this to calculate the expected present value of the loan repayments as at the date the
security is issued allowing for the probability of default and present valuing the cash ows.
Draft a report to the investor explaining how you have valued the bond and discussing the sen-
sitivity of the bond to the valuation assumptions. Your report should be a maximum of 1 (one) A4
page, 12 point font and assume that the investor is a retiree with limited knowledge of nance and
insurance.
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