Event Risk

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DEFINITION of 'Event Risk'

1. The possibility that an unforeseen event will negatively affect a company or industry. Unforeseen corporate reorganizations or bond buybacks may have positive or negative impacts upon the market price of a stock.

2. The risk associated with a changing portfolio value due to large swings in market prices. Also referred to as "jump risk" or "fat-tails." These are extreme portfolio risks due to substantial changes in market price.

3. The possibility that a bond issuer will miss a coupon payment to bondholders because of a dramatic and unexpected event. Credit rating agencies may downgrade the issuer’s credit rating as a result, and the company will have to pay investors more for the higher risk of holding its debt.

BREAKING DOWN 'Event Risk'

Companies can easily insure against some types of event risk, such as fire, but other events, such as terrorist attacks, may be impossible to insure against because insurers don’t offer policies that cover such unforeseeable and potentially devastating events. In some cases, companies can protect themselves against risks through financial products such as act of God bonds, swaps, options and collateralized debt obligations.

Another type of event risk is the possibility of a corporate takeover or restructuring such as a merger, acquisition or leveraged buyout. These events can require a firm to take on new or additional debt, possibly at higher interest rates, which it may have trouble repaying. Companies also face regulatory risk, in that a new law could require a company to make substantial and costly changes in its business model. For example, if the president signed a law making the sale of cigarettes illegal, a company whose business was the sale of cigarettes would suddenly find itself out of business.

Companies also face event risk from the possibility that the CEO could die suddenly, a key product could be recalled, the company could come under investigation for suspected wrongdoing, the price of a key input could suddenly increase substantially or countless other sources.

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