CFA Level I · CFA Level I Exam · Credit Risk
A bond is issued with a seniority ranking of senior unsecured. All else equal, compared with a subordinated bond from the same issuer, its expected recovery rate in default and its credit spread are most likely:
A senior unsecured bond most likely has a higher recovery rate and a narrower spread than a subordinated bond from the same issuer. Its higher priority in the claims waterfall reduces the expected loss given default, so investors demand less compensation for credit risk.
- Ahigher recovery rate and wider spread
- Blower recovery rate and narrower spread
- Chigher recovery rate and narrower spreadCorrect
Explanation
Senior claims rank ahead of subordinated claims, so expected recovery is higher. Higher recovery reduces expected loss, so investors require a smaller spread. The other options pair recovery and spread inconsistently with this relationship.
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