In December 2003, a European insurance company, Swiss Re, issued a 3-year floating-rate bond maturing on January 1, 2007, with a par value of US$400 million. The interest-rate payments were quarterly with a coupon reset formula of 3-month U.S. LIBOR plus 135 basis points. The principal at maturity was linked to a specifically constructed index of mortality rates (i.e., mortality index) across five countries(United States, United Kingdom, France, Italy, and Switzerland). The principal schedule at maturity called for repayment in full if the mortality index does not exceed 1.3 times the 2002 base level during any of the three years of the life of the bond. However, if the mortality index exceeded that level, there would be an increase of5% for every change in the index by 0.01.
(a) What was the purpose of Swiss Re issuingthis bond?
(b) The Swiss Re bond is referred to as a catastrophebond. Why?