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2、The cash flows of catastrophe bonds might be linked to:

 
      I. the firm’s dividend payments.
     II. internal loss events.
    III. industrywide underwriting losses.
    IV. an operational index.

A) II, III, and IV.
 
B) I only.
 
C) III and IV only.
 
D) II and III only.

nayizhenfeng

 The correct answer is A

Cat bonds, as they are known, can include cash flows from internal risk events (as in the case of indemnified notes), external risk events (as with parametric notes), or the value of an index (as with indexed notes). The firm’s dividend payment, however, is not a risk event and can be easily manipulated by the firm.

nayizhenfeng

 The correct answer is C

Indemnified notes are based on internal events and are subject to a moral hazard problem. Parametric notes are based on external events.

nayizhenfeng

AIM 5: Describe the characteristics of catastrophe options and catastrophe bonds.

 

1、The payoff for CBOT catastrophe options is most like:

A) a long put option.
 
B) a covered call option. 
 
C) an insurance policy with a deductible and co-insurance feature. 
 
D) a short futures contract. 

nayizhenfeng

The correct answer is C

The CBOT catastrophe option is designed as a spread option based on an index of underwriting property losses experienced by a large pool of insurers. Its spread feature combines a long call position with a low exercise price with a short call position at a higher exercise price. As a result, losses less than the lower exercise price and greater than the higher exercise prices are uninsured, creating a net payoff similar to an insurance policy with a deductible and co-insurance feature. Long puts and covered calls do not have spread-like payoffs.

nayizhenfeng

 The correct answer is D

All the bonds described above, except for one, are types of catastrophe bonds. Parametric notes link cash flows to the magnitude of an external risk event, such as hurricane severity in a particular region. Indemnified notes offer the issuing firm debt relief based on internal events, such as a large underwriting loss for an insurance company. Indexed notes provide cash flows related to the value of an independent index, such as a weather index or an insurance underwriting loss index. Bonds with cash flows determined by parametric distributions are quixotic

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3、Which of the catastrophe bonds are event based? Which are subject to the moral hazard problem?

A) Parametric; Indemnified.
 
B) Indemnified; Indemnified, Parametric.
 
C) Indemnified, Parametric; Indemnified.
 
D) Indemnified; Indemnified.

nayizhenfeng

The correct answer is A

Moral hazard is the notion that an insured will engage in more risky behavior than would be the case in the absence of insurance. Deductibles and co-insurance features cause the insured to participate in at least a portion of losses incurred by the firm. An insurance policy with a deductible does not cover losses below the deductible amount. A policy with a co-insurance feature does not cover losses above the co-insurance limit. Diversification and reinsurance are techniques insurance companies use to manage other risks.

nayizhenfeng

2、Parametric notes are fixed income instruments with cash flows:

A) determined by parametric distributions. 
 
B) that are triggered by internal risk events, such as fraud. 
 
C) linked to an index of underwriting losses. 
 
D) linked to an external risk event, such as an earthquake. 

nayizhenfeng

The correct answer is B

Parametric loss distributions and Extreme Value Theory use standardized distributions and Extreme Value Theory focuses on LFHS.