Question

The insurance company has recently sold large amount of bonds and invested the proceeds in real estate. Its logic was that this would reduce the exposure of its assets to interest rate risk. Do you agree? Explain.

This insurance company currently has a small amount of stock. The company expects that it will need to liquidate some of its assets soon to make payments to beneficiaries. Should it shift its bond holdings into stock in order to strive for a higher rate of return before its need to liquidate this investment?

Answer 1

While in investing in bonds you do take exposure to interest rate risks. Hence, to reduce it you can reduce your bond exposure. Interest rates do impact real estate as well. Investing in long term bonds can have huge interest rate risks. But to liquidate bond exposure in large amount was not correct. Real estate can have other risks as well. It does take time to liquidate and prices do fluctuate a lot. Instead we could have hedged our bond exposure and tried to reduce our interest rate risks. Interest rates if high can negatively impact the demand for real estate as it makes borrowing costly. Hence, we cannot agree with the given statement.

If payments are to be made in near term by liquidating assets, then stocks may not be a good option to invest in. As per the question, we do require high returns. But stock market returns generally take time. One should invest for long term in it. So for short term liabilities liquidating stock investments won't be a good option if we also want high returns.