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Definition: Act of God Bond
These are bonds issued by insurance companies to protect against contingent unforeseen events like floods or fires. It essentially links principal and Interest to a company’s losses due to natural disasters and hence creates flexibility for insurance companies in times of natural disasters.
If a catastrophe strikes the insurance companies are doomed, hence in order to share the risks the company issues an act of god bond .The companies aim to attract investors who are willing to take risk in return for a higher coupon payment(in comparison to treasury rates).
In Case the Catastrophe strikes: The investors are obliged to forgo a part of or the whole of Principal payment.
In Case the catastrophe does not strike Investors are assured payment of interest and principal and the returns are much higher than risk free rate of returns(Treasury Rates), Also investors will get a pattern of returns different from that of the stock and bond market .
These bonds are also called catastrophe bonds and they arise out of a need to reduce some risk in times of natural disasters for the insurance companies, which would incur damages which can’t be covered by the premiums which they receive. The insurance companies issue these bonds through investment banks