A high-yield bond (a type of insurance derivatives) that is usually used to provide insurance against catastrophes like earthquakes, hurricanes, floods, spillages, etc. In this type of bond, the lending agreement includes provisions that allow a debtor or the bond seller (the issuing entity, such as an insurance or reinsurance firm) to default fully (non-fulfillment of obligation) or partially (delayed fulfillment) on interest and/ or principal payments in cases where such “force majeure” events incur that debtor a loss.
CAT bonds offer a reliable source of diversification for investors due to their zero correlation with the broader market (especially that of stocks and bonds). Moreover, they enable investors to harvest higher yields in comparison with alternative investments.
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