LOS o: Describe the various forms of event risk.

Q1. All of the following risks are types of event risk EXCEPT:

A)   disaster/accident risk.

B)   interest rate risk.

C)   political risk.

Q2. Which of the following circumstances is an example of event risk?

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

B)   A bond's bid/ask spread widens.

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

Q3. 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)   If there are 16 rain events next year, SBG will recoup its premium.

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

C)   SBG's maximum loss is the premium.

Q4. 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)   Event Risk.

B)   Liquidity Risk.

C)   Call Risk.

Q5. Which of the following is NOT an example of event risk?

A)   A corporation calls a large bond issue.

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

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

LOS o: Describe the various forms of event risk.fficeffice" />

Q1. All of the following risks are types of event risk EXCEPT:

A)   disaster/accident risk.

B)   interest rate risk.

C)   political risk.

Correct answer is 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.

Q2. Which of the following circumstances is an example of event risk?

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

B)   A bond's bid/ask spread widens.

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

Correct answer is C)

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.

Q3. SBG Entertainment, an outdoor concert tour management company located in the northwestern ffice:smarttags" />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)   If there are 16 rain events next year, SBG will recoup its premium.

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

C)   SBG's maximum loss is the premium.

Correct answer is C)

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).

Q4. 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)   Event Risk.

B)   Liquidity Risk.

C)   Call Risk.

Correct answer is A)

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.

Q5. Which of the following is NOT an example of event risk?

A)   A corporation calls a large bond issue.

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

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

Correct answer is A)

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

The 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 LBO-related rating downgrade is an example of corporate event risk.

thanks