FRM Part I · FRM Exam Part I · Measuring Credit Risk
A bond with face value USD 100 trades after default at USD 38. A bank holds a USD 50 million face position in this senior unsecured bond, bought at par. What is the recovery rate and the loss to the bank, using the market price as the recovery measure?
The post-default price of USD 38 per USD 100 face implies a 38% recovery rate. The loss is the remaining 62% of USD 50 million, or USD 31 million. Confusing recovery with loss would reverse these figures.
- ARecovery 38%, loss USD 31 millionCorrect
- BRecovery 62%, loss USD 31 million
- CRecovery 38%, loss USD 19 million
- DRecovery 62%, loss USD 19 million
Explanation
Recovery rate = 38/100 = 38%. Loss = (1 - 0.38) x 50m = USD 31 million. Swapping recovery and loss rates gives 62% recovery and USD 19 million loss, which are the wrong values.
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