Chapter 16 - Unit pricing

Question 1

What does an internal unit-linked fund consist of

Answer 1

It consists of clearly identifiable set of assets, for Eg. Equities, properties, fixed-interest securities and deposits.

Question 2

What is the basic equity principle of unit pricing for an internal fund

Answer 2

The interests of unit-holders not involved in a unit transaction should be unaffected by that transaction

i.e. The creation and cancellation of units, and buying and selling units, should not give rise to a change in the net asset value per unit

Rationale:

• For unit holders the only prices relevant are those at which they buy units in the fund
  – and those at which they redeem their units.
• In theory, the movement in price between those two events should only reflect the performance of the assets backing the unit
  – and charges deductible under the policy provisions.
• Price should not be affected by creation or cancellation of other units,
  – otherwise, cross-subsidies between unit holders will arise.

Question 3

What is the Appropriation price

Answer 3

It is the amount of money put into the fund for EACH new unit created.

The amount of money put in is such that the net asset value PER UNIT is the same after as before the appropriation

Question 4

What is the Expropriation price

Answer 4

It is the amount of money the company takes out of the fund for each unit cancelled.

This amount of money is such that the net asset value per unit is the same after, as before, the expropriation

Continuing unit-holders should be unaffected by the unit cancellation.

Question 5

How to calculate the Appropriation price

Answer 5

-The market ‘Offer price’ value of the assets held by the fund plus the expenses that would be incurred in the purchase
+ the value of any current assets, such as cash on deposit or investments sold but not yet settled
- less the value of any current liabilities, such as investments purchased but not yet settled or loans to the fund
+ plus any accrued income, such as interest income form fixed-interest securities and deposits, net of any outgo, such as fund charges
- any allowance for accrued tax, if applicable

This gives the net asset value of the fund on an ‘Offer basis’
Divided by the number of units existing at the valuation date ( i.e. before any new units are created) gives the Appropriation price

Question 6

How to calculate the Expropriation price

Answer 6

The investments of the fund are valued at the market ‘bid basis’ and expenses that would be incurred in the sale are deducted.
+ the value of any current assets, such as cash on deposit or investments sold but not yet settled
- less the value of any current liabilities, such as investments purchased but not yet settled or loans to the fund
+ plus any accrued income, such as interest income form fixed-interest securities and deposits, net of any outgo, such as fund charges
- any allowance for accrued tax, if applicable

Divided by the number of units existing at the valuation date gives the expropriation price

Question 7

What is pricing on an offer basis

Answer 7

This is when the marginal transaction involves the creation of units.

This is the amount of money put into the fund being equal to the net number of units being created multiplied by the appropriation price.

Question 8

What is pricing on the bid basis

Answer 8

This is when the marginal transaction involves a cancellation of units.

This is the amount of money taken out of the fund being equal to the net number of units being cancelled multiplied by the expropriation price

Question 9

What are the adjustments usually made to the appropriation price that ends up being the offer price

Answer 9

Initial charges and Rounding

Question 10

What is the initial charges adjustments made to the appropriation price which in turn affects the offer price

Answer 10

When units are allocated to policyholders, companies may want to make an additional charge as a contribution to meeting other management expenses and commission payments and to profits.

This charge is also known as the ‘bid/offer’ spread.

Question 11

What is the Rounding made to the appropriation price which affects the offer price

Answer 11

It is normal to quote prices to a certain number of decimal places. This could be done by rounding the offer price up and bid price down. Or vice versa

Question 12

What is Offer and Bid price

Answer 12

Offer price - The price at which units are offered for sale to the policyholder
Bid price - The price at which units will be bought from the policyholder

Question 13

What is a Management box, and what are the key risks in keeping it?

Answer 13

A management box is when the company keeps more units in its internal linked funds than necessary. These excess of units facilitate the management of the fund. Some days there may be more policyholders selling units, while on other days there may be more policyholders buying units. If the company varies the number of units it owns in a box, it can reduce the need to cancel or create units each day.

Risks
- The value of the assets in the management box might drop
- Operational risks (eg. keep track of which units belong to policyholders and which to the company)
- Expenses of managing the box are higher than expected

Question 14

When would you expect to use the offer price / bid basis combination?

Answer 14

• The policyholder pays a premium to buy units from a contracting fund.