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DFA Insurance Company Case Study, Part I: - page 11 / 40

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Cash Equivalents

°

Government Bonds (1-5 years)

Government Bonds (5-10 years)

Government Bonds (10-30 years)

Corporate Bonds (1-5 years)

Corporate Bonds (5-10 years)

Corporate Bonds (10-30 years)

Municipal Bonds (1-5 years)

Municipal Bonds (5-10 years)

Municipal Bonds (10-30 years)

Common Stock

  • Preferred Stock

The economic and capital market simulation model required assumptions concerning the initial levels of interest rates, inflation rates, real GDP growth, equity earnings growth, equity P/E levels, and the dividend payout ratio together with a set of long-term levels to which the initial levels will revert over time. In setting the long-term levels, the goal was to produce risk premiums between asset classes that are consistent with historical data9.

For our DFAIC study, we have set long-term levels equal to the initial market conditions as of our model start date (1/1/2000). This avoids bias with respect to expected price appreciation or depreciation due to interest movements or changing P/E ratios over the

time horizon. Initial market conditions together with the assumed mean levels fo~:are shown in Table 1.

9For example, the spread between cash and inflation is historically about 2% and the risk premium for long government bonds over cash is about 2%.

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