Funding a 30-Day Surrender Wave with a Bond-Heavy Portfolio
You are treasurer of a mid-sized life insurer. Policyholder surrenders and agent commissions require $48 million net cash in 30 days. Invested assets total $210 million: $126 million in 8-12 year A-rated corporate bonds, $42 million in 90-day commercial paper, $21 million in Treasury bills, and $21 million in equities. You hold $8 million cash. Dealer indications: corporate bonds can be sold at a 1.8% discount to mark for normal size, but a 4.5% discount if more than $30 million is sold within five days; repo against corporate bonds carries a 6.1% rate, 10% haircut, and 35-day term; Treasury bills settle same day at a 0.15% discount; the commercial paper market is closed to your name. An internal limit caps assets with a haircut above 5% at 15% of total assets.
1. Quantify the 30-day liquidity gap and identify the lowest-cost funding mix that respects the internal haircut limit. Show the calculation.
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Net need is $48 million; cash is $8 million, so the gap is $40 million. Treasury bills provide 21 × (1 − 0.0015) ≈ $20.97 million, leaving $19.03 million. Repo against corporate bonds has a 10% haircut, so pledge 19.03 / 0.90 ≈ $21.14 million of corporate bonds. Repo interest is 19.03 × 6.1% × 35/360 ≈ $0.113 million; the T-bill discount costs about $0.032 million, for total cost near $0.145 million, or about 0.30% of the need. The pledged corporate bonds are 21.14 / 210 ≈ 10.1% of assets, below the 15% ($31.5 million) limit. Commercial paper cannot be assumed to roll, so it should not be counted as a funding source.
2. If the firm instead sells $40 million of corporate bonds, what is the all-in cost and why might the treasurer still choose that route?
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A sale above $30 million within five days triggers the 4.5% discount. Selling $40 million nets $38.2 million, leaving a $1.8 million shortfall. To net $40 million, sell 40 / (1 − 0.045) ≈ $41.88 million, crystallizing a $1.88 million discount. That is roughly 13 times the repo cost. The treasurer might still sell if repo lines are unreliable, if the firm wants to avoid a 35-day rollover cliff, or if the haircut limit is likely to be breached by other collateral. A sale also removes counterparty and margin risk, but it realizes an accounting loss, reduces future coupon income, and may create market impact because the sale is about 33% of the corporate bond bucket.
3. What liquidity risk remains if the commercial paper market stays closed for 90 days?
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The $42 million of commercial paper will mature and cannot be rolled. After using $8 million cash and about $21 million of T-bills, roughly $13 million of the first maturity must be met from repo or sales, but the repo matures in 35 days and must be rolled twice more in the 90-day window. If the CP market and repo market are both closed, the insurer faces fire sales of corporate bonds at the 4.5% discount or worse, plus possible equity sales. Surrenders may accelerate if policyholders learn of liquidity strain. The treasurer should pre-arrange a backup line, extend repo term, prepare a ranking of assets by sale cost, and communicate early with the regulator rather than rely on daily rollover.