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An insurance company in Florida is concerned about catastrophic hurricane losses. The insurer decides to issue some dollar - denominated bonds to U .
An insurance company in Florida is concerned about catastrophic hurricane losses. The insurer decides to issue some dollardenominated bonds to US investors. The bonds will have a $ maturity value, mature in years, and provide a percent annual interest coupon payment.
The bond indenture specifies that if a Category Hurricane hits Florida in any year, only of the annual interest will be paid, and if a Category Hurricane occurs, no interest is payable. Assume the investors agree with the meteorological estimates of the probabilities of major hurricanes, which are provided below. Further, assume that the annual probabilities are independent.
If the investorrequired rate of return YTM for these bonds is percent, what is the most an investor should be willing to pay for one of these newly issued CAT bonds?
Hurricane Category Probability Coupon Payment Expected Coupon Payment
Category $ $
Category $ $
Category $ $
Total $
Step : Calculate the expected coupon payment using the table above. PMT $
PMT $
NPER
FV $
RATE
Step : Use the PV function to calculate the bond value. PV $
Step : Calculate the PV of the only coupon payments. PV of coupon payments
Step : Calculate the PV of the only par value. PV of the par value
Step : Show that the bond value calculated above could also be found by adding up the value of the coupon payments and par value separately: Bond value
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