High-yield investors

A first kind of these insurance products are called "catastrophe bonds" and consist in securitizing environmental risks in bonds, which could be sold to high-yield investors. The catastrophe bonds are able to transfer risk to investors that receive coupons that are normally a reference rate plus an appropriate risk premium. By these products, insurance companies limit risk exposure transferring natural catastrophe risk into the capital markets. In this way, with the involvement of the financial markets, their global size offers enormous potential for insurers to diversify risks. 

Fallen angels are securities that started out as investment grade bonds and have ended up, or are expected to end up in high-yield territory, such as Marconi and KPN. The former rose substantially before the downgrade to high yield, as it formed a big part of the European high-yield index, and high-yield investors had no choice but to buy the name and bid up the price. 

The justification for this model is the fact that any share that sits well above the line (i.e. having a relatively high yield) for any reason will appear attractive to the market, investors will buy it, its price will rise as a result of this demand and its yield will thus fall back to the market line. Conversely, any share that is well below the line will appear unattractive, investors will sell, the price will fall and the yield will rise. 

The third phase of the European high-yield market s evolution appears to be following the US market s model, with an increased focus on higher qnality issuers, more investor-friendly debt structures, and expansion of the asset classes accessed by institutional investors. 

For illustrative purposes, it is worth considering the German experience of the 1990s in conjunction with the high-yield debt example mentioned previously. During this period, German institutional investors were seeking to diversify and increase their overall returns. This need... 

Firstly, we must establish the corporate existence of our new limited purpose minibank CASH CDO I—or CCDO I. CCDO I will be the vehicle by which we will attempt to intermediate the US high-yield market with the German institutional investor base. Exhibit 15.2 illustrates the mechanics described in this hypothetical example. 

An important constituent that we have not mentioned lately is the German institutional investor. For those that remember, the catalyst behind the overall transaction. Now that we have built the basic product or tool (CCDO I) to help intermediate the high-yield market to the investor, we should explore any tailoring the CDO can provide to the end investor. The vehicle thus far has been customised principally around the collateral and asset manager. 

Given this new landscape, in 2001, Fitch Ratings created a par based default index specific to the European high-yield market. The objective of this chapter is to compare and contrast default and recovery patterns across the two markets in order to give global bond investors and European investors, in particular, historical and current benchmarks for measuring credit risk. 

High-yield defaults in Europe in both 2001 and 2002 produced weighted average recovery rates significantly below US historical averages. Investors recovered just 11% of par value on 2001 defaults and 15% of par on 2002 defaults. In the United States, recovery rates on... 

To gain exposure to sectors where, for various reasons, they do not wish to make actual purchases, investors can use a variation on a TR swap called an index swap, in which one of the counterparties pays a total return tied to an external reference index and the other pays a LIBOR-linked coupon or the total return of another index. Indexes used include those for government bonds, high-yield bonds, and technology stocks. Investors who believe that the bank loan market will outperform the mortgt e-backed bond sector, for instance, might enter into an index swap in which they pay the total return of the mortgage index and receive the total return of the bank-loan index. 

Corporate bonds fall into two broad credit classifications investment-grade and high-yield (or "junk") bonds. The largest holders of corporate bonds are institutions,- the complexity as well as the fact that corporate bonds are fully taxable at all levels (federal, state, and local) usually makes individual investors shy away. 

The equation tells how many years it will take before the capital invested in the plant and equipment will be paid back. Generally, most investors will demand a payback period of three years or less before they will risk their money. In the electric power industry, which tends to have stable revenues, a payback period of seven years may be acceptable. Obviously, any venture which requires a high capital investment and yields a very low profit will have a long payback period, and the venture probably will not be financed. 

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