Spread risk

Capital is at risk until the breakeven point has been reached. It is common practice to give consideration to the discounted breakeven point (DEEP), the time at which the (NPV) is zero when discounting at the cost of capital. At any time after the (DEEP), the project will have recovered its cost and provided a greater return on the capital than the cost of capital. It is customary for management to spread risk by diversifying the activities of a company among a portfoho of projects. 

With this kind of financial products, the insurance industry tries to reach two goals. First, there is the need for extra capital and to spread risks beyond the insurance sector. Particularly, cat bonds are used to spread insurance risk in the financial sector. The second goal is to improve the accuracy and the resolution of hazard data and the likely impacts on climate change with the involvement of financial market forecast ability. 

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An increasingly strong argument in favor of renewables is their positive effects on security by spreading risk. At the crudest level this can be interpreted as... 

There are two main types of credit risk that a bond portfolio or position is exposed to. They are credit default risk and credit spread risk. Credit default risk is defined as the risk that the issuer will be unable to make timely payments of interest and principal. Typically, investors rely on the ratings agencies—Fitch Ratings, Moody s Investors Service, Inc., and Standard 8c Poor s Corporation—who publish their opinions in the form of ratings. 

Credit spread options are options whose payout is linked to the credit spread of the reference credit. This product can be used to manage the credit risk on corporate bond and corporate bond option positions. It isolates credit spread risk, which is an important factor in the underling... 

First, as mentioned earlier, there is usually no universal benchmark in a given market. Again, a possible approach, used in Barra s models, is to introduce a swap spread factor that describes the average spread between sovereign and swap rates and can conveniently allow spread risk to be expressed with respect to the LIBOR/swap curve when interest rate risk factors are originally based on the sovereign yield curve. 

This same factor can also be used to compute spread risk in markets where there is not enough data to build a detailed credit block. It can also be used in markets where more detailed credit factors are available, but when there is not enough information to expose a bond to the appropriate credit factor. As we will see in what follows, this will be the case when a euro- or sterling-denominated corporate bond is not rated. Based on the observation that bonds with larger spreads are on average more risky, Barra s model assumes the following exposure to the swap factor ... 

Swap spread volatilities for several currencies are shown in Exhibit 23.6, with values that vary from about 15 bp/year to 40 bp/year. Also shown are the resulting spread risks in the euro and sterling markets for several rating categories. We will see further below that the swap model predicts reasonably accurately both the absolute magnitude of the spread risk in each market and their relative values. 

The euro and sterling markets are broad and liquid markets. Accurately modeling spread risk in these two markets requires market-dependent, credit blocks. ... 

Each corporate bond will only be exposed to one of these factors, with an exposure that will typically increase with the bond s maturity. A rule of thumb is that it will be comparable to the bond s exposure to the shift factor. The spread risk of almost all AAA, AA, and A rated bonds will be less than their interest rate risk, and it is only for BBB rated bonds and in some very specific market sectors such as Energy and Telecoms that spread risk starts exceeding benchmark risk. Spread risk is by far the dominant source of systematic risk for high-yield instruments. 

Emerging market spread volatilities are shown in Exhibit 23.10. The spread risk of Latin American obligors tend to be above average, currently largest for Argentinean and Brazilian markets that have a spread risk comparable to a B to CCC rated euro corporate. The risk of Asian issuers is on the other hand below average and comparable to the interest rate observed in developed markets. We clearly observe a wide spectrum of risk characteristics that confirms the need to build a separate factor for each market. 

They should spread risk. This could be a marketing risk or the risk of crop failure, or another type of risk. 

Legal liability has already been discussed in some detail in the chapters dealing the market failures due to imperfect information and externalities. In the chapter on imperfect information, it was shown that liability will be insufficient to completely remove the market failure for passengers. This is because passengers will be risk averse. This is not to say that liability is bad and should not be deployed. Liability is a mechanism for spreading risk, and will reduce but not eliminate the market failure. The issue is less relevant for freight shippers, as they tend to be better informed than passengers. 

As a less costly alternative to acquisitions, joint ventures can be attractive. Joint ventures spread risk as well as investment. The most successful joint ventures are those between companies of relatively equal size and similar business cultures they are also usually limited to... 

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