CT5 Chapter 13: Profit Testing and Reserves

Introduction

• Presenter: MJ the Student Actree
• Overview of chapter: Profit Testing and Reserves
• Emphasis on ease of content, likened to "free marks"

Zeroization Technique

• Definition: A method used for creating reserves
• Purpose: To calculate the last non-zero reserve

Key Concepts

• Profit Vector:
  • A representation of cash flows, which includes both positive and negative values
  • Objective: To transform the profit vector by zeroizing negative values

Steps of Zeroization

1. Identify Negative Cash Flows

   • Start from the last negative entry in the profit vector
   • For example: If the fourth cash flow is negative, it’s identified for adjustment

2. Calculate Reserve

   • Formula: Reserve = - (Negative Cash Flow) / Interest
   • Example: If cash flow is -10.82, calculate reserve for year 3

3. Adjust Previous Cash Flow

   • Reduce the non-unit cash flow of the previous year by the calculated reserve multiplied by survival probability
   • Example: Year 3 value adjusted down by the new reserve

4. Repeat Process

   • Check if the adjusted entry is positive or negative
   • If negative, repeat the steps for the prior cash flow
   • Continue until all negative cash flows after year one are addressed

Results of Zeroization

• Process results in a positive or zero-only cash flow scenario
• Examples provided illustrate calculations and adjustments made in each step

Cheat Sheet

• A condensed version of the zeroization process for quick reference
• Encourage memorization for exam preparation

Conclusion

• Importance of mastering zeroization for the CT5 exam
• Encouragement to engage with the content and provide feedback
• Reminder that this is the penultimate chapter of CT5

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