Longevity swap and Present value: Difference between pages

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''Pensions risk management''.
(PV).  


A longevity swap is a derivative contract that offsets the risk of defined benefit pension scheme members living longer than expected.
Today’s fair value of a future cash flow, calculated by discounting the future cash flow at the appropriately risk adjusted current market [[cost of capital]].


It is a form of longevity hedge, protecting against the potentially adverse effects of longevity risk.


For example, if $110m is receivable one year from now, and the cost of capital (r) is 10% per year, the Present value is:


==See also==
PV = $110m x 1.1<sup>-1</sup>
*[[Defined benefit pension scheme]]
*[[Inflation swap]]
*[[Longevity]]
*[[Member]]
*[[Swap]]


[[Category:Manage_risks]]
= $100m.
 
 
And more generally:
 
PV = [[Future value]] x [[Discount factor]] (DF)
 
Where:
 
<math>DF = (1+r)^-n</math>
 
r = cost of capital per period; ''and''
 
n = number of periods
 
 
'''''Examples'''''
 
For example, if $10m is receivable one year from now, and the cost of capital (r) is 6% per year, the Present value is:
 
PV = $10m x 1.06<sup>-1</sup>
 
= '''$9.43m'''.
 
 
 
Now changing the timing in this example, if exactly the same amount of $10m is receivable but later, namely two years from now, and the cost of capital (r) is still 6% per year, the Present value falls to:
 
PV = $10m x 1.06<sup>-2</sup>
 
= '''$8.90m'''.
 
 
The longer the time lag before we receive our money, the less valuable the promise is today.
 
This is reflected in the lower Present value for the two years maturity cash flow of $8.90m, compared with $9.43m Present value for the cash flow receivable after only one year's delay.
 
 
== See also ==
* [[Adjusted present value]]
* [[Compounding factor]]
* [[Discount factor]]
* [[Annuity factor]]
* [[Discounted cash flow]]
* [[Future value]]
* [[Intrinsic value]]
* [[Net present value]]
* [[Profitability index]]
* [[Terminal value]]
* [[Time value of money]]
 
[[Category:Asset_and_Project_Finance]]
[[Category:Bank_Lending]]
[[Category:Debt_Capital_Markets]]
[[Category:Equity]]
[[Category:Trade_Finance]]
[[Category:Business_Valuation]]
[[Category:Investment_Appraisal]]
[[Category:Interest_Rate_Risk]]
[[Category:Pensions_Risk]]

Revision as of 21:37, 28 June 2013

(PV).

Today’s fair value of a future cash flow, calculated by discounting the future cash flow at the appropriately risk adjusted current market cost of capital.


For example, if $110m is receivable one year from now, and the cost of capital (r) is 10% per year, the Present value is:

PV = $110m x 1.1-1

= $100m.


And more generally:

PV = Future value x Discount factor (DF)

Where:

<math>DF = (1+r)^-n</math>

r = cost of capital per period; and

n = number of periods


Examples

For example, if $10m is receivable one year from now, and the cost of capital (r) is 6% per year, the Present value is:

PV = $10m x 1.06-1

= $9.43m.


Now changing the timing in this example, if exactly the same amount of $10m is receivable but later, namely two years from now, and the cost of capital (r) is still 6% per year, the Present value falls to:

PV = $10m x 1.06-2

= $8.90m.


The longer the time lag before we receive our money, the less valuable the promise is today.

This is reflected in the lower Present value for the two years maturity cash flow of $8.90m, compared with $9.43m Present value for the cash flow receivable after only one year's delay.


See also