CAIA - 36 - Structured Products II: Insurance-Linked Products and Hybrid Securities Flashcards
___-___ ___ are tradable financial instruments whose values are driven by an insured loss event.
Insurance-linked securities (ILS) are tradable financial instruments whose values are driven by an insured loss event.
___ ___are risk-linked debt instruments designed to transfer catastrophe risks from issuers to investors.
Catastrophe bonds are risk-linked debt instruments designed to transfer catastrophe risks from issuers to investors.
___ ___ represent the largest portion of the ILS market.
Cat bonds represent the largest portion of the ILS market.
Cat bonds are typically ___-rate with ___coupons and maturities of ___-___ years (most with ___ years)
Cat bonds are typically floating-rate with quarterly coupons and maturities of 1-5 years (most with 3 years)
Spreads on cat bonds have typically been between ___-___% with events occurring 1 in ___ to ___ years. Expected losses have historically been ___-___ basis points when an event occurs.
Spreads on cat bonds have typically been between 4-10% with events occurring 1 in 50 to 100 years. Expected losses have historically been 50-500 basis points when an event occurs.
With an ___ ___, payment to the issuer is based on actual excess claims paid by the issuer.
With an indemnity trigger, payment to the issuer is based on actual excess claims paid by the issuer.
The ___ ___of the trigger is the point at which at least part of the principal must be used to cover claims.
The attachment point of the trigger is the point at which at least part of the principal must be used to cover claims.
The ___ ___is the amount of claims loss at which the cat bond loses 100% of the principal and investors are not responsible for additional claims.
The exhaustion point is the amount of claims loss at which the cat bond loses 100% of the principal and investors are not responsible for additional claims.
The ___ ___is the estimated probability that the cat bond’ attachment point will be reached.
The attachment probability is the estimated probability that the cat bond’ attachment point will be reached.
An ___ ___ ___ is based on index estimates of total industry losses due to the insured event.
An industry loss trigger is based on index estimates of total industry losses due to the insured event.
The indemnity trigger is advantageous for ___ and unfavorable for ___.
The indemnity trigger is advantageous for issuers and unfavorable for investors.
Indemnity triggers can create ___ ___since issuers have an incentive to underwrite excessive risk.
Indemnity triggers can create moral hazard since issuers have an incentive to underwrite excessive risk.
Industry loss triggers are settled ___ than indemnity triggers.
Industry loss triggers are settled faster than indemnity triggers.
With a ___ ___, payment to the issuer is triggered when a certain threshold is surpassed based on prespecified parameters of a natural event in a specified location.
With a parametric trigger, payment to the issuer is triggered when a certain threshold is surpassed based on prespecified parameters of a natural event in a specified location.
With a ___ ___, payment to the issuer is based on estimated claims generated by a computer model, which provides estimates of losses for an exposure portfolio given various extremes of a natural disaster.
With a modeled trigger, payment to the issuer is based on estimated claims generated by a computer model, which provides estimates of losses for an exposure portfolio given various extremes of a natural disaster.
Cat bonds have (the same/less/more) liquidity than most equities and corporate bonds.
Cat bonds have less liquidity than most equities and corporate bonds.
Cat bonds payoff distribution (is/is not) highly skewed with significant ___ tail risk.
Cat bonds payoff distribution is highly skewed with significant downside tail risk.
___ ___aims to earn short-term, low risk profits from pricing discrepancies due to complicated investment traits.
Complex arbitrage aims to earn short-term, low risk profits from pricing discrepancies due to complicated investment traits.
___ ___is the risk that policyholders and pensioners have higher than projected life expectencies.
Longevity risk is the risk that policyholders and pensioners have higher than projected life expectencies.
Longevity risk can be hedged using index-based and indemnity-based ___ ___ ___.
Longevity risk can be hedged using index-based and indemnity-based longevity swap contracts.
In ___-based longevity swap contracts, if a pension plan’s beneficiaries live longer than assumed, the pension plan will receive higher payments from the counterparty.
In indemnity-based longevity swap contracts, if a pension plan’s beneficiaries live longer than assumed, the pension plan will receive higher payments from the counterparty.
In ___-based contracts, an increase in general longevity will result in higher payments from the counterparty to the plan.
In index-based contracts, an increase in general longevity will result in higher payments from the counterparty to the plan.
Pension plans that hold longevity swap contracts are exposed to the following risks:
- C___
- R___
- B___
- L___
Pension plans that hold longevity swap contracts are exposed to the following risks:
- Counterparty
- Rollover
- Basis
- Legal
___ risk refers to the risk that pension plans’ hedging contracts have shorter maturities than the liabilities they are trying to cover.
Rollover risk refers to the risk that pension plans’ hedging contracts have shorter maturities than the liabilities they are trying to cover.
___ risk refers to the risk that, when index-based longevity contracts are used, the pension plan’s mortality experience differs from that of the index used in the contract.
Basis risk refers to the risk that, when index-based longevity contracts are used, the pension plan’s mortality experience differs from that of the index used in the contract.
___ risk arises if longevity swaps are not exchange traded.
Legal risk arises if longevity swaps are not exchange traded.
___ risk is the risk that a person dies sooner than expected.
Mortality risk is the risk that a person dies sooner than expected.
Who is mortality risk borne by?
Who is mortality risk borne by?
Families of breadwinners and insurance companies
___ are the primary cause of increased mortality rates
Pandemics are the primary cause of increased mortality rates
Life insurance policies (do/do not) typically include war as a covered cause of death.
Life insurance policies do not typically include war as a covered cause of death.
Catastrophic mortality bonds may have (higher/lower) diversification benefits than non-life cat bonds.
Catastrophic mortality bonds may have lower diversification benefits than non-life cat bonds.
A ___ ___ ___ refers to the sale of a life insurance policy to a third party, who becomes its beneficiary and assumes the payment of the premiums.
A life insurance settlement refers to the sale of a life insurance policy to a third party, who becomes its beneficiary and assumes the payment of the premiums.
The ___ ___is the price at which the insurance company will buy back its commitments under a contract.
The surrender value is the price at which the insurance company will buy back its commitments under a contract.
A policyholder and a purchaser of a policy as an investment both benefit if:
A policyholder and a purchaser of a policy as an investment both benefit if:
surrender value < purchase price < NPV of cash flows
A ___ ___ is a transaction in which a terminally ill policyholder sells his life insurance policy at a discount to its face value to a third party.
A viatical settlement is a transaction in which a terminally ill policyholder sells his life insurance policy at a discount to its face value to a third party.
A transaction is considered a viatical settlement if the policyholder’s life expectancy is less than ___ years. Otherwise it is considered a ___settlement.
A transaction is considered a viatical settlement if the policyholder’s life expectancy is less than 2 years. Otherwise it is considered a life settlement.
Viatical settlements are (tightly/loosely) regulated in many U.S. states.
Viatical settlements are tightly regulated in many U.S. states.
Life settlements have (high/low) correlations with other asset classes.
Life settlements have low correlations with other asset classes.
___ ___ is a hybrid of debt and equity financing typically used by profitable companies to fund expansion projects, acquisitions, and management and leveraged buyouts.
Mezzanine debt is a hybrid of debt and equity financing typically used by profitable companies to fund expansion projects, acquisitions, and management and leveraged buyouts.
___ ___ ___ is Mezzanine Debt has the following characteristics:
- Subordinated debt with detached equity warrants
- Principal repaid after senior
- Cash coupon
- Equity warrants may have 0/low exercise price
Debt with Warrants is Mezzanine Debt has the following characteristics:
- Subordinated debt with detached equity warrants
- Principal repaid after senior
- Cash coupon
- Equity warrants may have 0/low exercise price
___ ___are mezzanine debt that are:
typically subordinated
principal paid at maturity
More dilutive than debt with warrants
Usually applied during an IPO
Convertible loans are mezzanine debt that are:
typically subordinated principal
paid at maturity
More dilutive than debt with warrants
Usually applied during an IPO
___ ___are mezzanine debt with the following characteristics:
- Base interest rate + performance spread
- Interest rate lined to net profit, EBITDA, or sales
- No equity
- Difficult to structure
Participating loans are mezzanine debt with the following characteristics:
- Base interest rate + performance spread
- Interest rate lined to net profit, EBITDA, or sales
- No equity
- Difficult to structure
Debt with ___-___or ___ ___ is mezzanine debt with the following characteristics:
- Subordinated with deferred interest
- No equity participation
- Principal repayment back ended
- Not appropriate for longer-term finance
Debt with Step-up or deferred interest is mezzanine debt with the following characteristics:
- Subordinated with deferred interest
- No equity participation
- Principal repayment back ended
- Not appropriate for longer-term finance
___ ___ ___ is mezzanine debt that:
- Similar to conv debt except default doesn’t accelerate other debt or bankruptcy
- Essentially senior equity
- Used in start up financing
Convertible preferred equity is mezzanine debt that:
- Similar to conv debt except default doesn’t accelerate other debt or bankruptcy
- Essentially senior equity
- Used in start up financing
___ covenants include limitations on asset sales, debt issuance, control changes, restricted payments, affiliate transactions, and liens.
Negative covenants include limitations on asset sales, debt issuance, control changes, restricted payments, affiliate transactions, and liens.
___ covenants may require maintenance of insurance, financial reporting, and compliance with certain regulations.
Affirmative covenants may require maintenance of insurance, financial reporting, and compliance with certain regulations.
Mezzanine returns are earned from ____ and ____payments.
Mezzanine returns are earned from current and deferred payments.
___ ___ ___ interest is paid by increasing the principal via capitalization of interest payments.
Payment in kind interest is paid by increasing the principal via capitalization of interest payments.
A ___ ___is an extra negotiated payment.
A bonus payment is an extra negotiated payment.
___ ___with ___-___rates is used when a firm cannot assume more fixed-rate debt since its senior and subordinated debt are depleting its cash flows.
Subordinated debt with step-up rates is used when a firm cannot assume more fixed-rate debt since its senior and subordinated debt are depleting its cash flows.
Step-up debt typically uses a ___ model where a fixed rate is paid plus a variable rate depending on performance.
Step-up debt typically uses a hybrid model where a fixed rate is paid plus a variable rate depending on performance.
Subordinated debt with PIK interest have maturities of ___-___ years.
Subordinated debt with PIK interest have maturities of 7-8 years.
PIK interest (is/isn’t) typically tax deductible.
PIK interest is typically tax deductible.
A ___ ___ is sometimes paid by the borrower of a PIK loan to compensate the lender for the time lag between the commitment on the loan and the actual disbursement.
A ticking fee is sometimes paid by the borrower of a PIK loan to compensate the lender for the time lag between the commitment on the loan and the actual disbursement.
Subordinated debt with ___ ___provides mezzanine lenders a risk balance between debt and equity, offering downside protection and participation in the upside potential.
Subordinated debt with profit participation provides mezzanine lenders a risk balance between debt and equity, offering downside protection and participation in the upside potential.
Warrants are issued by unlisted firms and, thus, regarded as ___ securities.
Warrants are issued by unlisted firms and, thus, regarded as OTC securities.
Debt with warrants (is/is not) dilutive.
Debt with warrants is dilutive.
Debt with warrants (are/are not) standardized.
Debt with warrants are not standardized.
Debt with warrants typically have (longer/shorter) maturity than options.
Debt with warrants typically have longer maturity than options.
___ ___are similar to bonds with a warrant attached, except the option component of ___ ___is embedded in the fixed-income instrument.
Convertible bonds are similar to bonds with a warrant attached, except the option component of convertible bonds is embedded in the fixed-income instrument.
Most convertibles (are/are not) callable.
Most convertibles are callable.
Compared to non-covertible bonds, convertibles provide issuers 2 advantages:
- L
- L
Compared to non-covertible bonds, convertibles provide issuers 2 advantages:
- Lower interest rates
- Less restrictive covenants
