Cash Flow Models and Matching

Study Notes

A cash flow model is a numerical projection of payments from financial transactions. Income is positive, outgo is negative.
Net cashflow is the difference between income and outgo at a single point in time.
Actuarial models can assign probabilities to the amount and existence of uncertain cash flows.
In some businesses, like insurance, investment income is received in relation to premiums received before claims and expenses are paid.
Positive values represent cash inflows, negative values represent cash outflows.

Providers deliver benefits through asset investment.
A key provider decision is whether to match expected cash flows from assets with expected cash flows from liabilities.
Matching assets to liabilities requires determining the optimal matched position.
If assets are not matched to liabilities, additional capital (free assets) is needed to cover potential shortfalls, creating a cushion against market fluctuations.

Book Value: The value an asset is held at in a company's accounts.
Market Value: The amount an asset can be sold for on the open market. This is easily identifiable for assets actively traded, like stocks and bonds.
Experts Valuers: Can estimate market values for assets without an objective market price, like property, based on recent sales of similar assets.
Mark-to-Model: Asset valuation using a pricing model when no obvious market value exists.
Mark-to-Model valuations are used for complex or unusual assets and when market value is different from fair value.

Certain cash flows are classified as follows: Types of security or investment (a financial contract bought and sold)

A financial contract offering a lump sum at a specified future date.
Investor experiences a negative cash flow at investment and a positive cash flow on the specified future date.

Businesses, local authorities, or governments can raise money by floating loans on the stock exchange.
These loans can take the form of fixed-interest securities, issued in bonds with a stated nominal amount.
The holder of a bond receives a lump sum at a specified future time, along with regular level interest payments until the bond matures.

Protects against inflation, which diminishes the purchasing power of money.
Interest payments and capital repayment are linked to an index that reflects inflation.
Results in an initial negative cash flow followed by unknown positive cash flows, all on specified dates.
Amounts of future cash flows relate to the inflation index, making them known despite their unknown value.