The risk that the ability of an issuer to make interest and principal payments will change because of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural or industrial accident or some regulatory change or (2) a takeover, or corporate restructuring.
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The risk that an unpredictable, non-repeating event will cause a loss. A strike at a factory or an accident that renders a mine inoperable are examples of event risk. Insurance is intended to lessen many event risks.
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The risk that some unexpected event will cause a substantial decline in the market value of a security. For example, a leveraged buyout that entails huge amounts of new debt will cause a decline in the market value of the target company's outstanding debt.
Case Study The September 11, 2001, terrorist attacks with hijacked airliners on New York's World Trade Center and Washington's Pentagon caused death and destruction on a monumental scale. The tragic events also had an effect on numerous businesses, including insurance companies, hotels, cruise lines, and brokerage and investment banking firms that conducted much of their activities from the impacted area of New York City. Trading of stocks in the United States was halted from September 11 until September 17. On a national scale no industry was affected more than commercial airlines. Four large passenger jets lost to suicidal terrorists were only the tip of the iceberg for an industry that was already on a downward economic slide. The hijackings on the morning of September 11 caused the Federal Aviation Administration to ban all commercial airline traffic in the United States for most of three days, an expensive proposition for airlines that experts estimated did business at a quarter of a billion dollars daily. The airlines were already experiencing a major decline in profitable business travel, and the hijackings caused fearful leisure travelers to cancel existing bookings and reduce their own airline travel. Analysts were expecting industry losses in 2001 of $2.5 to $3.5 billion prior to the attack. Following the attack these estimates ranged upward to $5 billion with some forecasts of several industry bankruptcies. One smaller firm, North Carolina-based Midway Airlines, threw in the towel and permanently shut down all of its operations on the day following the terrorist attack. Continental Airlines was the first airline to announce large layoffs of 12,000 employees. Other airlines soon followed with employment and schedule reductions of their own at the same time as they requested billions of dollars in federal financial assistance. Airlines incur substantial fixed expenses, including salaries and lease payments, that must be taken care of regardless of how many people purchase tickets. High fixed costs mean that reduced load factors (a smaller percentage of filled seats by paying passengers) have a major impact on the firms' income. When equity markets reopened on Monday following the disaster, airline stock declines from the prior Monday included 52% for US Airways, 49% for Continental, 44% for Delta, 42% for UAL (parent of United Airlines), and 39% for AMR (parent of American Airlines). One terrible event resulted in unexpected financial distress and extensive shareholder losses in an already troubled industry.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.