Bank Leus Prima Cat Bond Fund Harvard Case Solution & Analysis

Bank Leu’s Prima Cat Bond Fund

Q1.) Explain the pros and cons of Cat bonds and Cat bond funds.

Cat Bonds

Advantages

Since, every investor wants his investment to be well-diversified and the risk as well as returns of a catastrophic bond do not correlate with any other underlying asset or instrument; instead they are based on the happening of a natural disaster or similar event, therefore, catastrophe bonds effectively diversify the investment risk.

Moreover, returns on catastrophe bonds do not depend on economic cycle in the market that means with no regards to the performance of economy. Meanwhile, the cat bonds offer higher yields in comparison to the Treasury bond that makes it more attractive to the investors. In addition, cat bonds offer the same return in relation to a highly risky investment.

However, the insurance premiums paid to investors are regarded as a form of capital gain, hence; the investors’ investment in cat bonds is not subject to income taxes. Moreover, the pricing of cat bond is affected by the credit agencies; therefore, the price of cat bonds can be affected by speculation.

Disadvantages

Cat bonds value and returns are affected by global climate cycle as well as changes in environmental conditions and these conditions along with the climate cannot be exactly forecasted in order to reduce or eliminate the risk returns and value associated with cat bonds.

Moreover, if a catastrophic event takes place, then the investor will have to lose returns and part or whole of his principle investment. Further, there is no ready market for cat bonds where the investor can resell them; therefore, it increases the liquidity risk of investors.

Cat Bond Funds

Advantages

However, the cat bond funds provide an opportunity to individual investors for investing their money in catastrophe bonds; which they can not avail due to the lack of availability of bond funds.

The individual investors do not have very good knowledge of capital market and cat bond funds are an easily understandable product because it pays out fixed return in line with the LIBOR with some additional risk premium, moreover, the risk that those investors will face is mainly based on the happening of some natural disaster.

Disadvantages

Since pricing of cat bonds is affected by rating agencies and biasness of credit rating agency towards unrelated or less important event; hence, it will adversely affect the cat bond price. Additionally, cat bond funds are subject to regulatory requirements and the offer of cat bond funds have to comply with those governing regulations and deciding upon the asset class for cat bond funds is a complicated task because the later subscription of cat bond funds will depend on the asset class of funds.

Q2.) From an asset allocation perspective, do Cat bond Funds make sense for private and institutional investors?

From an investor’s point of view, investment in cat bond funds will bring many benefits and will increase the attractiveness of these bonds, meanwhile, cat bond funds enable investors to diversify their risk because investors will like to lower the risk of losing all its investment due to the happening of a single event, therefore, investors will like to allocate its portfolio in those investments which are not directly or indirectly linked to each other. Moreover in doing so, the investor will look for un-correlated investment opportunities and bond funds can provide an exceptional investment opportunity to investors because returns on cat bond funds are not linked to economic changes such as inflation, interest rates, etc.; instead the payment of returns and repayment of principle is conditional to the occurrence of a catastrophic event in the future. Additionally, the happening of that catastrophic event is dependent on the global climate that is not linked to any other instrument; therefore, a change in any other instrument will not affect the returns from cat bonds that will diversify the portfolio effectively.

Catastrophe bond funds diversify the investors risk effectively and protect the steady stream of returns over the life of cat bonds; therefore, it is sensible for institutional investors and private investors to investment in cat bond funds.

Q3.) Discuss the pros and cons of offering Cat bond funds to investors from Bank Leu perspective.

Advantages

After the launch of cat bonds, Bank Leu had felt the absence of retail cat bond funds and decided to launch its in-house cat bond funds with the view that its customers would interested to invest in cat bonds in order to enjoy the fringe benefits of cat bonds, which would make sure that the successful launch of cat bond funds.

Moreover, the offering will increase the investor base because more individual investors will invest in cat bond funds of Bank Leu. Additionally, the participants of cat bond funds will be the existing customers of Bank Leu and they ..................................

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In 2001, Bank Leu, the Swiss private bank, is considering the possibility of creating the first public funds in the world for the catastrophe bonds. Cat bonds are securities, the payment depends on the likelihood of disaster occurring, such as an earthquake or hurricane. Cat bonds are traditionally issued by major insurance and reinsurance companies. This case describes the traditional reinsurance market and securitization efforts that have taken place in the past, and focus on solving the Bank Leu, both buy-side participants cat bond market. "Hide
by George Chacko, Vincent Dessain, Anders Sjoman, Adam Plotkin, Peter Hecht Source: Harvard Business School 23 pages. Publication Date: September 2, 2004. Prod. #: 205005-PDF-ENG

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