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By Diego Wauters (CEO of Coriolis Capital Limited, London) and Martin Jones (CIO of Coriolis Capital Limited, London): In the last eight years, a number of new instruments have appeared in the financial markets. Among them, catastrophe bonds and weather derivatives have quickly grown from scratch to reach a size of US$16 billion in notional each.
Catastrophe bonds tend to cover a few extreme events caused by Mother Nature. These include earthquakes, hurricanes and typhoons, and events of the size required to affect a catastrophe bond tend to occur once or twice a century. Investors typically subscribe to the bonds, and receive a return on their principal of Libor plus a spread, which compensates them for the risk they are taking. If a covered event of a large enough size occurs (as measured by either some physical measurement, such as the magnitude of an earthquake, or by the size of insurance losses under a particular set of contracts) the investors stand to lose part or all of their principal. Otherwise, if nothing happens, the investors get their principal back at maturity. Such bonds are normally issued by insurance or reinsurance companies (and occasionally corporations) to cover their exposures to such catastrophes.
Weather derivatives, on the other hand, protect corporations in such industries as energy, agriculture, food and beverage, and construction against day-to-day fluctuations in the weather - namely rain, snow, tempera...................... To view our full article Click here
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