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Occasionally, the ability of an issuer to make interest & principal payments is seriously & unexpecttedly change by a nature or industrial accident or a takeover or corporate restructuring.These risks are referred to as event risk.The cancellation of plans to build a nuclear power plant illustrates the first type of event in relation to the utility industry.
As example of the second type of event risk is the takeover in 1988 of RJR Nabisco for $25 billion via a financing technique known as a leveraged buyout (LBO).In such a transaction,the new company incurred a substantial amount of debt to finance the acquisition of the firm.Because the corporation was required to service a substantially larger amount of debt, its quality rating was reduced to noninvestment grade quality.As a result, the change in yield spread to a benchmark Treasury,demanded by investor because of the LBO announcement, increaased from about 100 basis pints to 350 basis pints.
There are also spillover effects of event risk on other firms. For example if there is a nuclear accident, this will affect all utilities producing nuclear power.
Sector Risk.
Bonds in different sector of the market respond differently to environmental changes because of a combination of some or all of the above risks, as well as others. Examples include discount versus premium coupon bonds.The possibility of adverse differential movement of specific sectors of the market is called sector risk.
Other Risks.
The various risks of investing in the fixed income markets reviewed in this chapter do not represent the entire range of risks.In the market place, it is customary to combine almost all risks other than market risk (Interest rate risk) & refer to it as basis risk.
As example of the second type of event risk is the takeover in 1988 of RJR Nabisco for $25 billion via a financing technique known as a leveraged buyout (LBO).In such a transaction,the new company incurred a substantial amount of debt to finance the acquisition of the firm.Because the corporation was required to service a substantially larger amount of debt, its quality rating was reduced to noninvestment grade quality.As a result, the change in yield spread to a benchmark Treasury,demanded by investor because of the LBO announcement, increaased from about 100 basis pints to 350 basis pints.
There are also spillover effects of event risk on other firms. For example if there is a nuclear accident, this will affect all utilities producing nuclear power.
Sector Risk.
Bonds in different sector of the market respond differently to environmental changes because of a combination of some or all of the above risks, as well as others. Examples include discount versus premium coupon bonds.The possibility of adverse differential movement of specific sectors of the market is called sector risk.
Other Risks.
The various risks of investing in the fixed income markets reviewed in this chapter do not represent the entire range of risks.In the market place, it is customary to combine almost all risks other than market risk (Interest rate risk) & refer to it as basis risk.
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