1. Briefly describe the difference between an "historic volatility" derived from price data (exchange rate changes in this case) and an "implied volatility" extracted

from an option premium. Which do you think is likely to be the better indicator of future volatility? Please thoroughly explain your answer.

2. The AIM Holding Company, Inc. is an American based holding company that has subsidiaries selling various types of insurance in the United States and in a number of foreign countries. AIM-Europa is the holding company's European subsidiary.

AIM-Europa sells lifetime annuity policies across the Euro Zone (the countries that use the euro as their currency). To be clear, a policy pays a fixed number of euros each month for the life of the policyholder and ceases immediately upon the policyholder's death. The proceeds from the sale of these annuities are transferred to the U.S. where the money is invested in U.S. corporate bonds. In all cases, the monthly payouts to the policyholders were calculated to return 2.75% per annum based on the policyholder's life expectancy. While the actual life-spans of the individual annuity holders are uncertain, AIM-Europa relies on actuarial studies to estimate life expectancies and payouts.

At present, if AIM-Europa does not sell any more policies, its current situation is as follows: It is obligated to pay out 20,625,000 monthly for the next 20 years. As already noted, this payout represents a return to the policy holders of 2.75% per annum. The U.S. bond portfolio that supports the annuity policies has been structured to generate $47,431,600 per month, which represents a 4% annual return, for the next 20 years. Both the 2.75% return to the annuity holders and the 4% return to the company assume monthly compounding. Note that the EUR:USD spot exchange rate is currently $1.427.

What risks do you see AIM-Europa exposed to that could make it difficult for it to meet its obligations to the annuity holders down the road? Please identify at least three such risks and describe them thoroughly.