cashflow of simple financial products
- 2. INTRODUCTION A cashflow model is a mathematical projection of the payments arising from a financial transaction. Payments received = income = positive cashflows Payments made = outgo = negative cashflows The difference at a single point in time is called the net cashflow.
- 3. CASHFLOW MATCHING Providers deliver benefits through the investment of assets. A key decision for the provider is whether or not to invest in such a way that the expected cashflows from the asset held match the expected cashflows from the liabilities. If the decision is taken not to match then additional capital will need to be held to cover the possibility that there are insufficient asset to meet the liabilities when they fall due
- 4. CASHFLOW PROCESS Cashflows are sums of money which are paid or received at different times. Timing and amount of the cashflows may be known or unknown. In some businesses, such as insurance companies, positive cashflows are received before negative cashflows. Where there is uncertainty about the amount or timing of cashflows, assign probabilities to both the amount and the existence of a cashflow.
- 5. EXAMPLES OF CASHFLOW SCENARIOS
- 6. AN ANNUITY An annuity provides a series of regular payments in return for a single premium. For an immediate annuity payments are made as long as the annuitant is alive. The cash flow for the investor initial negative cashflow followed by a series of smaller regular positive cashflows. The cashflow for the annuity provider initial positive cashflow followed by an unknown number of regular known negative cashflows. The number of future negative cashflows depends on the probability of the policyholder.
- 7. TERM ASSURANCE A term assurance provides a lumpsum on the death of the policyholder provided that this occurs during the term of the policy. It is usually purchased by a series of annual premiums ,generally of constant amount. For the provider There will be an unknown number of regular known positive cashflows Followed by either a negative cashflow of known amount but uncertain timing or No negative cash flow
- 8. ENDOWMENT ASSURANCE There will be a negative cashflow for the provider at the maturity date of the contract,if the sum assured has not already been paid on earlier death. Combination of term assurance and pure endowment assurance
- 9. AN INTEREST –ONLY LOAN An interest only loan is repayable by a series of interest payments followed by a return of the initial loan amount. The cashflows are the reverse of those for fixed interest security. The interest rate need not be fixed in advance .The regular cashflows may therefore be of uknown amounts.
- 10. A REPAYMENT LOAN A repayment loan is repayable by a series of amounts each of which includes partial repayment of the loan capital in addition to the interest payment. The cashflows are similar to those for an annuity certain.
- 11. MOTOR INSURANCE A motor insurance policy will provide cover for a period of one year. In return for a premium received at the start of the start of the year, or on a regular basis, an insurance company will accept the financial risk which are associated with the policyholders motoring