FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies
A distressed company has 100 of senior bonds, widely held by many small investors, and negotiations aim at an exchange offer to reduce debt. Which problem most directly makes an out-of-court restructuring of such dispersed public debt difficult?
The main difficulty is holdout, or free-rider, behavior. Each small bondholder hopes others accept the exchange and improve the firm's health while they keep full claims, so coordination fails. Tools such as exit consents or prepackaged bankruptcy are used to address this.
- AHoldout behavior, where individual bondholders refuse to participate hoping others accept and improve their own recoveryCorrect
- BMandatory conversion of all bonds into equity under the indenture
- CAutomatic acceleration of all secured loans on any exchange offer
- DRegulatory prohibition on exchanging bonds for new securities
Explanation
With dispersed holders, each has an incentive to free-ride: if others accept the exchange, the firm becomes healthier and holdouts are paid in full. This coordination problem is why exit consents, prepackaged plans or sweeteners are used. The other options are not general features of bond workouts.
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