In March 2022, $330,000,000 notional of CAT bond was issued and listed in Bermuda Stock Exchange. You can check the listing here. The bond pays the coupon of (Floating Rate) + 5%, unless the “indemnity” trigger is activated. The trigger is defined as the sponsor’s (the ceding insurance company – North Carolina Insurance Underwriting Association) loss from North Carolina named storm & severe thunderstorm exceeding $1.85 billion (this is called the “attachment point”), and up to $330 million will be covered. You can read the full description of this deal from here.

Assume that you manage a billion dollar fund in a hedge fund, and you are considering to purchase the entire $330 million bond yourself. For simplicity, assume that the CAT bond is 1-year (instead of 3-year in reality) bond with annual coupon payment at the end of the year, and the annualized floating rate is 0.5% (i.e. the total coupon is 5.5% of notional). What is the cashflow and the realized return on your investment when the total loss from North Carolina’s named storm & severe thunderstorms is (i) $1 billion (ii) $2 billion, and (iii) 3 billion? Assume that all the losses occur the day before the maturity, which means you receive the 1-year worth of coupon for the protection you provided during the year.

Answer rating: 100% (QA)

Lets break down the cash flow and realized return for each scenario i Total loss from North Carolinas named storm severe thunderstorms is 1 billion Cash Flow You receive the annual coupon payment of 5... View the full answer