Reading 63: Risks Associated with Investing in Bonds - LO

答案和详解如下：

1.Kira Sigard, CFA and an attorney with an investment banking firm, structures a client’s bond issue to include a “poison put.” This is a provision that requires the issuer to redeem the bond at par in the case of a corporate takeover, a merger, or anti-takeover measure that would dissipate significant corporate assets. An investor who purchases this bond is protected from what type of risk?

A)   Call Risk.

B)   Reinvestment Risk.

C)   Event Risk.

D)   Liquidity Risk.

The correct answer was C)

Event risk refers to the possibility that there may be a single event or circumstance that could have a major effect on the ability of an issuer to repay a bond obligation. The poison put specifically protects an investor from corporate event risk.

Call Risk, or prepayment risk, is the risk that the issuer will repay principal prior to maturity. Prepayments are most likely to occur in a declining interest rate environment because it is cheaper to issue replacement debt. Liquidity risk addresses how quickly and easily an investor can sell a bond. Reinvestment risk is the risk that if rates fall, cash flows will be reinvested at lower rates, resulting in a holding return lower than that expected at purchase. Here, the investor will likely have to reinvest the coupon at the lower market interest rate, negatively impacting his holding period return.

2.SBG Entertainment, an outdoor concert tour management company located in the northwestern United States, holds approximately 80 concerts per year. SBG recently hired Stuart Frye, CFA. Frye enters into the following cap contract: SBG will receive $100,000 for each rain event (defined as cancellation due to inclement weather) over 13 rain events (maximum payments of $1,000,000). The premium, or cost of this agreement, is $300,000. Given this information, which of the following statements is FALSE?

A)   The cap contract forces SBG to absorb some rain risk.

B)   If there are 16 rain events next year, SBG will recoup its premium.

C)   The cap contract reduces SBG's exposure to event risk.

D)   SBG's maximum loss is the premium.

The correct answer was D)

In this simple example, SBG would recoup its premium if there are 16 rain events next year: [ (16 – 13) * 100,000)] = 300,000.

Although the cap contract does reduce SBG’s event risk, it still leaves SBG exposed to the risk of the first 13 rain events. In addition, SBG will be responsible for losses exceeding $1,000,000 (23 rain events).

3.Which of the following circumstances is an example of event risk?

A)   A bond's bid/ask spread widens.

B)   A local government regulatory agency introduces more stringent clean-water requirements that will significantly reduce the cash flow of an area paper mill.

C)   The U.S. Federal Reserve unexpectedly increases interest rates by 100 basis points.

D)   A currency devalues due to foreign exchange market forces.

The correct answer was B)

A local government regulatory agency introducing more stringent clean-water requirements that will significantly reduce the cash flow of an area paper mill is an example of regulatory risk, which is a type of event risk. The impact of regulatory risk can be long-term, in that the company may be unable to pass on the increased cost to customers.

The other choices are examples of other types of risk that bondholders face. A widening bid-ask spread indicates increased liquidity risk. The Federal Reserve’s action is an example of interest rate risk. The currency’s devaluation is an example of currency risk.

4.All of the following risks are types of event risk EXCEPT:

A)   disaster/accident risk.

B)   interest rate risk.

C)   regulatory risk.

D)   political risk.

The correct answer was B)

Interest rate risk is the risk that interest rates will increase, decreasing the price of certain investments, including fixed-coupon bonds.

The other choices are examples of event risk, which refers to the possibility that there may be a single event or circumstance that could have a major effect on the ability of an issuer to repay a bond obligation.

5.Which of the following is NOT an example of event risk?

A)   An interim South American government imposes restrictions on the outflow of capital.

B)   The U.S. Food and Drug Administration (FDA) determines that a biotech company's flagship product is harmful to consumers and cannot be marketed.

C)   A corporation calls a large bond issue.

D)   Ratings agencies downgrade a company's rating after the company takes on a significant amount of debt to fund a leveraged buy-out (LBO).

The correct answer was C)

A corporation calling a large bond issue is an example of call risk.

All other choices are examples of types of event risk, which includes disaster/accident, corporate, regulatory, and political risks. Event risk refers to the possibility that there may be a single event or circumstance that could have a major effect on the ability of an issuer to repay a bond obligation. The South American government’s actions are an example of political event risk. The FDA’s actions represent regulatory event risk. The LBO-related rating downgrade is an example of corporate event risk.