2006 Hurricane Risk

2006 Hurricane Risk :

Suzanne Feller’s Decision :

1 Amount to be invested in Cat Notes 15% of $125 millions = $18.75 Million

2 Face value of cat notes available at $18.75 mn is $21551724

Trigger Event : Occurrence of two distinct Gulf or East Coast Hurricane which may cause Insurance Industry loss of $ 20 billion or more

Decision tree

Decision : Whether to invest in cat notes or not

Events : Event A Two distinct hurricanes causing $20 billion loss

Probabilities :

p1 : probability of occurrence of two distinct hurricanes( Gulf and East Coasts ) each causing loss of $20 billion or more to Insurance Industry = 0.01

1-p1 : probability of non occurrence of two distinct hurricanes( Gulf and East Coasts ) each causing loss of $20 billion or more to Insurance Industry = 0.99

Cash flows :

CF1 : The net return that Suzanne Feller will get after investing $18750000,if two hurricanes occur causing insurance losses of $20 bn or more

= -$18750000+$0 = -$18750000

CF2 : The net return that Suzanne Feller will get after investing $18750000,if two hurricanes does not occur causing insurance losses of $20 bn or more

= -$18750000+$21551724 = $2801724

CF3 : The net return that Suzanne Feller will get after investing $18750000 in risk free bonds giving yield of 5% , if two hurricanes occur causing insurance losses of $20 bn or more

= 5% of $18750000 = $937500

CF4 : The net return that Suzanne Feller will get after investing $18750000 in risk free bonds giving yield of 5% , if two hurricanes occur causing insurance losses of $20 bn or more

= 5% of $18750000 = $937500

Expected Monetary Value :

EMV1 : The expected monetary value of returns if Suzanne Feller decides to invest $18750000 in cat notes = P1 x CF1 + (1-P1)CF2 = .01 x (-) 18750000 +0.99 x 2801724 = $ 2961206.76

EMV2 : The expected monetary value of returns if Suzanne Feller does not invest $18750000 in cat notes = P1 x CF3 + (1-P1)CF4 = .01 x 937500 +0.99 x...