Explanation:
Correct answer: D
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Q-703.3. Catastrophe (CAT) bonds are a popular derivative instrument for hedging catastrophic risk. A CAT bond pays a higher-than-normal interest rate and is often issued by a subsidiary of an insurance company. Each of the following is TRUE about the features of a CAT bond EXCEPT which is false?
A
For an insurance company, issuing CAT bonds is an alternative to reinsurance: the interest or principal can be used to meet claims
B
CAT bonds tend to have little or no correlation to market returns such that their total risk can be diversified away in a large portfolio
C
A drawback of CAT bonds is the covered loss depends on a definition of "catastrophic loss" which is inevitably subjective and qualitative so that the issuer's basis risk is high
D
An inevitable feature of catastrophic risk is that the loss events are highly dependent on each other; the loss events are not independent and usually they are not even nearly independent