CAIA - 36 - Structured Products II: Insurance-Linked Products and Hybrid Securities Flashcards Preview

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Flashcards in CAIA - 36 - Structured Products II: Insurance-Linked Products and Hybrid Securities Deck (62)
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1
Q

___-___ ___ are tradable financial instruments whose values are driven by an insured loss event.

A

Insurance-linked securities (ILS) are tradable financial instruments whose values are driven by an insured loss event.

2
Q

___ ___are risk-linked debt instruments designed to transfer catastrophe risks from issuers to investors.

A

Catastrophe bonds are risk-linked debt instruments designed to transfer catastrophe risks from issuers to investors.

3
Q

___ ___ represent the largest portion of the ILS market.

A

Cat bonds represent the largest portion of the ILS market.

4
Q

Cat bonds are typically ___-rate with ___coupons and maturities of ___-___ years (most with ___ years)

A

Cat bonds are typically floating-rate with quarterly coupons and maturities of 1-5 years (most with 3 years)

5
Q

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.

A

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.

6
Q

With an ___ ___, payment to the issuer is based on actual excess claims paid by the issuer.

A

With an indemnity trigger, payment to the issuer is based on actual excess claims paid by the issuer.

7
Q

The ___ ___of the trigger is the point at which at least part of the principal must be used to cover claims.

A

The attachment point of the trigger is the point at which at least part of the principal must be used to cover claims.

8
Q

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.

A

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.

9
Q

The ___ ___is the estimated probability that the cat bond’ attachment point will be reached.

A

The attachment probability is the estimated probability that the cat bond’ attachment point will be reached.

10
Q

An ___ ___ ___ is based on index estimates of total industry losses due to the insured event.

A

An industry loss trigger is based on index estimates of total industry losses due to the insured event.

11
Q

The indemnity trigger is advantageous for ___ and unfavorable for ___.

A

The indemnity trigger is advantageous for issuers and unfavorable for investors.

12
Q

Indemnity triggers can create ___ ___since issuers have an incentive to underwrite excessive risk.

A

Indemnity triggers can create moral hazard since issuers have an incentive to underwrite excessive risk.

13
Q

Industry loss triggers are settled ___ than indemnity triggers.

A

Industry loss triggers are settled faster than indemnity triggers.

14
Q

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.

A

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.

15
Q

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.

A

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.

16
Q

Cat bonds have (the same/less/more) liquidity than most equities and corporate bonds.

A

Cat bonds have less liquidity than most equities and corporate bonds.

17
Q

Cat bonds payoff distribution (is/is not) highly skewed with significant ___ tail risk.

A

Cat bonds payoff distribution is highly skewed with significant downside tail risk.

18
Q

___ ___aims to earn short-term, low risk profits from pricing discrepancies due to complicated investment traits.

A

Complex arbitrage aims to earn short-term, low risk profits from pricing discrepancies due to complicated investment traits.

19
Q

___ ___is the risk that policyholders and pensioners have higher than projected life expectencies.

A

Longevity risk is the risk that policyholders and pensioners have higher than projected life expectencies.

20
Q

Longevity risk can be hedged using index-based and indemnity-based ___ ___ ___.

A

Longevity risk can be hedged using index-based and indemnity-based longevity swap contracts.

21
Q

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.

A

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.

22
Q

In ___-based contracts, an increase in general longevity will result in higher payments from the counterparty to the plan.

A

In index-based contracts, an increase in general longevity will result in higher payments from the counterparty to the plan.

23
Q

Pension plans that hold longevity swap contracts are exposed to the following risks:

  1. C___
  2. R___
  3. B___
  4. L___
A

Pension plans that hold longevity swap contracts are exposed to the following risks:

  1. Counterparty
  2. Rollover
  3. Basis
  4. Legal
24
Q

___ risk refers to the risk that pension plans’ hedging contracts have shorter maturities than the liabilities they are trying to cover.

A

Rollover risk refers to the risk that pension plans’ hedging contracts have shorter maturities than the liabilities they are trying to cover.

25
Q

___ 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.

A

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.

26
Q

___ risk arises if longevity swaps are not exchange traded.

A

Legal risk arises if longevity swaps are not exchange traded.

27
Q

___ risk is the risk that a person dies sooner than expected.

A

Mortality risk is the risk that a person dies sooner than expected.

28
Q

Who is mortality risk borne by?

A

Who is mortality risk borne by?

Families of breadwinners and insurance companies

29
Q

___ are the primary cause of increased mortality rates

A

Pandemics are the primary cause of increased mortality rates

30
Q

Life insurance policies (do/do not) typically include war as a covered cause of death.

A

Life insurance policies do not typically include war as a covered cause of death.

31
Q

Catastrophic mortality bonds may have (higher/lower) diversification benefits than non-life cat bonds.

A

Catastrophic mortality bonds may have lower diversification benefits than non-life cat bonds.

32
Q

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

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.

33
Q

The ___ ___is the price at which the insurance company will buy back its commitments under a contract.

A

The surrender value is the price at which the insurance company will buy back its commitments under a contract.

34
Q

A policyholder and a purchaser of a policy as an investment both benefit if:

A

A policyholder and a purchaser of a policy as an investment both benefit if:

surrender value < purchase price < NPV of cash flows

35
Q

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

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.

36
Q

A transaction is considered a viatical settlement if the policyholder’s life expectancy is less than ___ years. Otherwise it is considered a ___settlement.

A

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.

37
Q

Viatical settlements are (tightly/loosely) regulated in many U.S. states.

A

Viatical settlements are tightly regulated in many U.S. states.

38
Q

Life settlements have (high/low) correlations with other asset classes.

A

Life settlements have low correlations with other asset classes.

39
Q

___ ___ is a hybrid of debt and equity financing typically used by profitable companies to fund expansion projects, acquisitions, and management and leveraged buyouts.

A

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.

40
Q

___ ___ ___ is Mezzanine Debt has the following characteristics:

  1. Subordinated debt with detached equity warrants
  2. Principal repaid after senior
  3. Cash coupon
  4. Equity warrants may have 0/low exercise price
A

Debt with Warrants is Mezzanine Debt has the following characteristics:

  1. Subordinated debt with detached equity warrants
  2. Principal repaid after senior
  3. Cash coupon
  4. Equity warrants may have 0/low exercise price
41
Q

___ ___are mezzanine debt that are:

typically subordinated

principal paid at maturity

More dilutive than debt with warrants

Usually applied during an IPO

A

Convertible loans are mezzanine debt that are:

typically subordinated principal

paid at maturity

More dilutive than debt with warrants

Usually applied during an IPO

42
Q

___ ___are mezzanine debt with the following characteristics:

  1. Base interest rate + performance spread
  2. Interest rate lined to net profit, EBITDA, or sales
  3. No equity
  4. Difficult to structure
A

Participating loans are mezzanine debt with the following characteristics:

  1. Base interest rate + performance spread
  2. Interest rate lined to net profit, EBITDA, or sales
  3. No equity
  4. Difficult to structure
43
Q

Debt with ___-___or ___ ___ is mezzanine debt with the following characteristics:

  1. Subordinated with deferred interest
  2. No equity participation
  3. Principal repayment back ended
  4. Not appropriate for longer-term finance
A

Debt with Step-up or deferred interest is mezzanine debt with the following characteristics:

  1. Subordinated with deferred interest
  2. No equity participation
  3. Principal repayment back ended
  4. Not appropriate for longer-term finance
44
Q

___ ___ ___ is mezzanine debt that:

  1. Similar to conv debt except default doesn’t accelerate other debt or bankruptcy
  2. Essentially senior equity
  3. Used in start up financing
A

Convertible preferred equity is mezzanine debt that:

  1. Similar to conv debt except default doesn’t accelerate other debt or bankruptcy
  2. Essentially senior equity
  3. Used in start up financing
45
Q

___ covenants include limitations on asset sales, debt issuance, control changes, restricted payments, affiliate transactions, and liens.

A

Negative covenants include limitations on asset sales, debt issuance, control changes, restricted payments, affiliate transactions, and liens.

46
Q

___ covenants may require maintenance of insurance, financial reporting, and compliance with certain regulations.

A

Affirmative covenants may require maintenance of insurance, financial reporting, and compliance with certain regulations.

47
Q

Mezzanine returns are earned from ____ and ____payments.

A

Mezzanine returns are earned from current and deferred payments.

48
Q

___ ___ ___ interest is paid by increasing the principal via capitalization of interest payments.

A

Payment in kind interest is paid by increasing the principal via capitalization of interest payments.

49
Q

A ___ ___is an extra negotiated payment.

A

A bonus payment is an extra negotiated payment.

50
Q

___ ___with ___-___rates is used when a firm cannot assume more fixed-rate debt since its senior and subordinated debt are depleting its cash flows.

A

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.

51
Q

Step-up debt typically uses a ___ model where a fixed rate is paid plus a variable rate depending on performance.

A

Step-up debt typically uses a hybrid model where a fixed rate is paid plus a variable rate depending on performance.

52
Q

Subordinated debt with PIK interest have maturities of ___-___ years.

A

Subordinated debt with PIK interest have maturities of 7-8 years.

53
Q

PIK interest (is/isn’t) typically tax deductible.

A

PIK interest is typically tax deductible.

54
Q

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

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.

55
Q

Subordinated debt with ___ ___provides mezzanine lenders a risk balance between debt and equity, offering downside protection and participation in the upside potential.

A

Subordinated debt with profit participation provides mezzanine lenders a risk balance between debt and equity, offering downside protection and participation in the upside potential.

56
Q

Warrants are issued by unlisted firms and, thus, regarded as ___ securities.

A

Warrants are issued by unlisted firms and, thus, regarded as OTC securities.

57
Q

Debt with warrants (is/is not) dilutive.

A

Debt with warrants is dilutive.

58
Q

Debt with warrants (are/are not) standardized.

A

Debt with warrants are not standardized.

59
Q

Debt with warrants typically have (longer/shorter) maturity than options.

A

Debt with warrants typically have longer maturity than options.

60
Q

___ ___are similar to bonds with a warrant attached, except the option component of ___ ___is embedded in the fixed-income instrument.

A

Convertible bonds are similar to bonds with a warrant attached, except the option component of convertible bonds is embedded in the fixed-income instrument.

61
Q

Most convertibles (are/are not) callable.

A

Most convertibles are callable.

62
Q

Compared to non-covertible bonds, convertibles provide issuers 2 advantages:

  1. L
  2. L
A

Compared to non-covertible bonds, convertibles provide issuers 2 advantages:

  1. Lower interest rates
  2. Less restrictive covenants

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