Modeling Accumulated Capital and Foreign Exchange Rate as a Tool for Decision Making

1.0 Introduction

Investment is a vital financial instrument for accumulating wealth in order to reduce the effect of inflation and increase value of money over time. In the reinsurance business context the purpose for building wealth is to make profit and meet liability obligation of settling claims to the insured of insurance and reinsurance contracts. The existence of insurance and reinsurance has contributed immensely to the development of the economy by averting losses in this risky society and ensuring solvency of insurance company businesses. The business of insurance involves the payment of a fixed amount called premium by an insured costumer to an insurer who accepts the eventual risk of occurrence and is obliged to settle a claim that arises in the future .while reinsurance is the insurance of risk underwriting (insurance companies) firms from the ruin of bankruptcy. Financial capital is exposed to market risk, which is the risk of loss in value of financial assets due to potential adverse movement of market factors like interest rate, commodity prices, foreign exchange rate, insurance prices etc. In this report we will focus on the effects of interest rate and foreign exchange volatility (risk) to reinsurance and insurance business. Also we will model an estimate of the accumulated financial capital invested in an investment portfolio with fluctuating (varying) interest rate, using stochastic interest rate model and modeling of foreign exchange rates using regression analysis.

The principle of reinsurance emanates from the pooling of funds for reduction of risk exposure by insuring a large number of high risky policy with low loss function of funds when a little number of event occurs. Payment is made out of the pooled fund to settle a claim that arises. Reinsurance business is becoming increasingly international. Therefore, the impact of foreign exchange risk has to be dealt with by both insurance firms and...