burning0spear

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.

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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.

burning0spear

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.

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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.

burning0spear

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

A) interest rate risk.

B) disaster/accident risk.

C) political risk.

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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.