Posted in Finance, Accounting and Economics Terms, Total Reads: 75
Definition: Catastrophe Bond
Catastrophe bond is an investment instrument which allows the investor to invest their money on the catastrophic events and earn returns from it. It is mostly issued by the insurance linked companies in order to protect and hedge themselves against any catastrophic events and protect them for major cash outflows during that period.
In this type of instrument the company or a third party issues coupon bonds to the investors with fixed periodic coupon payments along with principal repayment at maturity as normal bonds. But the condition here is that the investor will lose its principal amount if a catastrophic event occurs and will not get back its principal at maturity. So this makes it a high risk-high yield instrument for the investors.
Catastrophic events can be any events such as earthquakes, cyclones, tornado, tsunami etc.
This instruments transfer the risk from issuer to the investors and the issuer will use the money to provide coverage to the sponsor/counterparty.
Here a special purpose vehicle (SPV) or issuer comes into agreement between sponsors and assures him to provide cover during the catastrophe in return for premiums. Here the sponsors are normally insurance companies or reinsurance companies or any entity who are affected to a huge extent by any catastrophe while the investors can be any individuals.