What is the difference between event risk and headline risk?

Question

What will be an ideal response?

Answer 1

There are two unique risks that that can change corporate credit spreads: event risk and headline risk. The difference between these two risks is as follows. In the case of event risk, upon the announcement of some event there is an almost immediate credit rating downgrade for the adversely impacted corporation, sector, or industry.Hence, event risk is tied to downgrade risk.With headline risk, on the other hand, the announcement results in an adverse impact on the credit spread, as with event risk, but does not result in an immediate downgrade of debt. More details are given below.

An example of event risk is a corporate takeover or corporate restructuring. A specific example of event risk is the 1988 takeover of RJR Nabisco for $25 billion through a financing technique known as a leveraged buyout(LBO). The new company took on a substantial amount of debt incurred to finance the acquisition of the firm.In the case of RJR Nabisco, the debt and equity after the leveraged buyout were $29.9 and $1.2 billion, respectively. Because the corporation must service a larger amount of debt, its bond quality rating was reduced; RJR Nabisco's quality rating as assigned by Moody's dropped from A1 to B3 . The impact of the initial LBO bid announcement on the credit spreads for RJR Nabisco's debt was an increase from 100 basis points to 350 basis points. Event risk can have spillover effects on other firms. Consider once again the RJR Nabisco LBO. An LBO of $25 billion was considered impractical prior to the RJR Nabisco LBO, but the RJR transaction showed that size was not an obstacle, and other large firms previously thought to be unlikely candidates for an LBO became fair game resulting in an increase in their credit spread.

An example of headline risk is a natural or industrial accident that would be expected to have an adverse economic impact on a corporation. For example, an accident at a nuclear power plant is likely to have an adverse impact on the credit spread of the debt of the corporation that owns the plant. Just as with event risk, there may be spillover effects.