A catastrophe bond is an instrument which insures the insurer in cases of special events. These events are natural disasters like earthquakes and Tsunamis. In simple terms, an insurance company in case of a natural disaster incurs a loss. This bond helps in getting the money equivalent to the loss or less or more. Insurance companies take Catastrophe bonds which give insurance related to property or land. The issue is given the money of the bond only when the event happens. In case the event happens, the payout and the interest due is either forgiven or it is postponed for the future. These bonds yield high returns than any fixed income bonds as the risk involved is even higher.
Economic catastrophe bonds are the bonds which incur only when certain kind of economic situation occurs. Like catastrophe bonds, they also insure when there are worst situations in the economy. They have high yields as there is a small probability of default. Further, they also have a price which is discounted compared to normal un-economic bonds. It is due to the variations of returns is different states are huge. This is important when the recent trends in financial securities are studied properly. This security is created by pooling different financial security. They have different risk factors to hedge against the risk of an economic situation.