How Do Catastrophic Bonds Work?

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A catastrophic bonds operates like most other bonds with the exception that when it is issued, it has the ability for the debt to be forgiven. Find out why higher interest rates are paid with catastrophic bonds with help from a licensed financial planner in this free video on bonds and investing.

Part of the Video Series: Bond Investing
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Video Transcript

My name is Bill Rae. I'm with Alumni Financial Services. I've been in the business of the finance world for well over 20 years and today's question is how do catastrophic bonds work? Well I would suggest we first start off by understanding what a bond is. A bond is a debt or borrowed money that an authorized issuer would pass out, say you a debt holder. In other words they borrow money and they owe it to you and they generally pay it back in interest until an agreed upon time when the debt is to be repaid. Bonds can be either less than one year or more than one year. If they're less than one year generally it is called a short term bond. If it is more than one year it is usually called a long term bond. Now catastrophic bonds are becoming more popular but I should start off by telling you I'm not here to offer any advice in buying or selling stocks or bonds, just to get an understanding of what a catastrophic bond is. A catastrophic bond operates the same way most bonds would operate with this exception. When a catastrophic bond is issued it has in it the ability for the debt to be forgiven for instance if a state wanted to issue a bond to protect against disasters if you will or to build and they have in their bond the ability to say if a hurricane for instance comes in and wipes everything out, that debt is totally forgiven and is passed back to the investor so it comes with the risk that you can lose your entire principle. However, they generally pay a higher interest rate so again you really need to make sure that you understand what it is that you're getting involved in, talk with a licensed professional, as in all things financial understand the agreement you are getting involved in or the contract you are signing, make sure you understand what is required of you, how long your money is going to be on hold or when and how you can get it back if you will and the amount of money you expect to get back and as always seek competent licensed advice.

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