What would be the difference between an investor and a sponsor in the market for catastrophe derivatives? Is it that sponsors would be short (assuming there will be no adverse event) while investors would be generally long (assuming there will be an adverse event, e.g., hurricane etc.)? All input appreciated! Many thanks.
Hey mst. Good question. catastrophe bonds: 1) investor: receives cpn & receives principal if there isn’t a catastrophe 2) sponsor: invests proceeds in f.i. instruments to pay cpn & keeps principal in case there is a catastrophe I think the confusing part is: 1) are long and short in regards to a position with a catastrophe bond? 2) are long and short in regards to a position with catastrophe risk? The sponsor: basically he’s rid himself of the catastrophe risk because he can use the bond principal if something happens. I guess you can say he is “short” since he’s selling the catastrophe risk off. You definitely can say he’s “short the catastrophe bond.” The investor: basically he’s buying a catastrophe bond for the coupon and hopefully will receive principal at the end. I’m not sure you can necessarily say the investor is “long” in terms of catastrophe risk because he’d end up losing principal. But you definitely can say “long catastrophe bond” because he’s buying a bond for the coupon. I hope that helped???
Thank you JaRvEy, this cleared things up for the most part. Per your explanation it may be correct to say “the sponsor is long catastrophe risk and short the cat bond”, while the opposite is true for the investor, which was the root of my confusion. Many thanks again!