Disaster Bonds/Catastrophe Bonds Introduction Economics is fundamentally described as an area of study that is mainly concerned with the creation, utilization and transfer of wealth. Correspondingly, the idea of macro economics is principally described as the branch of economics emphasizing on studying the approach of decision-making for the upliftment of an economy…
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This is owing to the reason that these bonds are viewed to be risk-related securities which tends to uplift the position of an economy by raising huge amount of money during any sort of catastrophe such as the occurrence of floods, earthquakes and hurricanes among others (Coval, Jurek & Stafford, 2008). In this paper, a brief overview and a detailed explanation about this class of bonds, i.e. catastrophe bonds will be taken into concern. Moreover, the interrelation of these bonds with the conceptions of systematic (market) risk and idiosyncratic risk along with interest-rate risk will be considered. Various aspects that include the association of CAT bonds with the Theory of Asset Demand and comparison of these bonds with more common types of bonds and a comprehensive explanation about the advantages along with the disadvantages possessed by the aforementioned bonds will also be discussed in the paper. 1) Overview and Explanation of Disaster or Catastrophe (CAT) Bonds Disaster or Catastrophe (CAT) Bonds are usually regarded as high yield and risk-associated debt instruments or securities that are largely executed with the motive of raising money in the occurrence of catastrophes such as hurricanes, floods and earthquakes and other natural calamities. In general, these bonds can be typically characterized as high-yield debt appliances that are normally insurance-connected and are used to raise huge amount of money during the occurrence of any sort of catastrophe. It has been apparently observed in this context that these sort of bonds posses a special condition which represents that if a particular issuer i.e. an insurance or a reinsurance company experiences any loss from a specific catastrophe, the debt of the issuer concerning the payment of interest or the principal repayment figure is either totally overdue or completely forgiven (Coval, Jurek & Stafford, 2008). The prime intention of CAT bonds has been identified as transferring the risk caused by any kind of catastrophe particularly from the insurance industry towards capital markets. It has been viewed in this regard that these sorts of bonds are commonly used in various advanced nations with the intention of mitigating the issues or problems resulting from the occurrence of catastrophes. The CAT bonds became quite popular in certain business markets that comprise Europe, United States and Japan among others. However, in common instances, it has been the insurers who broadly execute theses bonds as a substitute towards reinsurance. It is in this context that the different insurance or reinsurance organizations issue these kinds of bonds and place them in front of different investors. This activity of the insurance or reinsurance organizations ultimately helps them towards transferring certain proportion of risks to those investors. In this regard, the various insurance or reinsurance companies can further endow a substantial proportion of their invested amount in any other financial sphere by selling CAT bonds. It is the government or the different financial institutions that possess the authority of issuing these bonds by a considerable extent (Coval, Jurek & Stafford, 2008). In order to analyze CAT bonds, it has been apparently observed that these bonds were initially introduced or issued in the midst of 1990s, during the repercussion of
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