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Motivation
Aug. 11th, 2009 08:16 pmThere was an interesting financial story this morning, one for you financial tecchies (tekkies?)
If you go to www.artemis.bm you might find a reference to it, but the bloke there uttered a refreshingly blunt "fucked if I know why they are doing this".
So, here's the nub of the story. Catastrophe bonds are fun bits of finance. There's lots of complications involved, but, in essence, one company sells a bond which another company buys. This bond pays fixed interest (a "coupon") and you get your principal back on maturity (usually three years).
The catch is, these bonds are tied to possible catastrophes, and if such a catastrophe occurs, you can lose all of your investment.
So, an energy insurer called Olic established one of these bonds in 2005. In 2007 a disaster happened (it was a gas pipe exploding in New York) that MIGHT, just might, mean that the investors would lose all or part of their investment. As with mortgage-backed-securities, these deals are split into tranches, and it was the middle tranche (innovatively called "Class B") that was/is touch-and-go. The safer and lower interest Class A looked fine, while the riskier and higher interest class C looked to be in shit street.
Now, when you get this kind of "possible" loss when the bond matures, it's time to look at the small print. In this case, Olic was allowed to postpone repayment of the principle for up to 24 months, just in case loss developments took a turn for the worse.
Anyhoo, this bond matured a year ago, and yesterday Olic in effect offered to "buy out" the investors for between 80 and 85 cents on the dollar. It's a modified Dutch auction, meaning that the investors put a sealed bid in an envelope stating how much they will accept. Only just over a third of the bonds will be bought back, so there's some double-guessing going on anyway. But that's rather besides the point. The question the investors should ask themselves is, "why is Olic doing this"?
If Olic think that the tranche is safe, then they are trying to get the bonds back on the cheap, and thus should be rejected. If (and I am not sure on the details on this) the interest is still paid while the repayment is postponed, then perhaps they think that it's better to get out of the deal now so that their capital can be put to better use.
Alternatively, it might just be some kind of capital management exercise that I don't understand.
But it's an interesting one, where the motivation of the bidder, rather than the amount being bid, should be what dictates your response. It's a land of unevenly distributed information, where the person being asked to set the price is the one who knows fuck-all, while the potential buyer probably has a better idea of the real value of the product.
Difficult land, finance.
____________
If you go to www.artemis.bm you might find a reference to it, but the bloke there uttered a refreshingly blunt "fucked if I know why they are doing this".
So, here's the nub of the story. Catastrophe bonds are fun bits of finance. There's lots of complications involved, but, in essence, one company sells a bond which another company buys. This bond pays fixed interest (a "coupon") and you get your principal back on maturity (usually three years).
The catch is, these bonds are tied to possible catastrophes, and if such a catastrophe occurs, you can lose all of your investment.
So, an energy insurer called Olic established one of these bonds in 2005. In 2007 a disaster happened (it was a gas pipe exploding in New York) that MIGHT, just might, mean that the investors would lose all or part of their investment. As with mortgage-backed-securities, these deals are split into tranches, and it was the middle tranche (innovatively called "Class B") that was/is touch-and-go. The safer and lower interest Class A looked fine, while the riskier and higher interest class C looked to be in shit street.
Now, when you get this kind of "possible" loss when the bond matures, it's time to look at the small print. In this case, Olic was allowed to postpone repayment of the principle for up to 24 months, just in case loss developments took a turn for the worse.
Anyhoo, this bond matured a year ago, and yesterday Olic in effect offered to "buy out" the investors for between 80 and 85 cents on the dollar. It's a modified Dutch auction, meaning that the investors put a sealed bid in an envelope stating how much they will accept. Only just over a third of the bonds will be bought back, so there's some double-guessing going on anyway. But that's rather besides the point. The question the investors should ask themselves is, "why is Olic doing this"?
If Olic think that the tranche is safe, then they are trying to get the bonds back on the cheap, and thus should be rejected. If (and I am not sure on the details on this) the interest is still paid while the repayment is postponed, then perhaps they think that it's better to get out of the deal now so that their capital can be put to better use.
Alternatively, it might just be some kind of capital management exercise that I don't understand.
But it's an interesting one, where the motivation of the bidder, rather than the amount being bid, should be what dictates your response. It's a land of unevenly distributed information, where the person being asked to set the price is the one who knows fuck-all, while the potential buyer probably has a better idea of the real value of the product.
Difficult land, finance.
____________
