Skip to content

FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A distressed debt fund holds senior secured bonds of a firm in Chapter 11 and is assessing a reorganization plan. Which statement about the fund's risk and return drivers is most accurate?

Distressed debt returns depend chiefly on the recovery value and the time to resolution given the claim's seniority under absolute priority, and tend to have low correlation with broad equity markets. Equity ranks below secured creditors, and coupons may stop in bankruptcy.

  1. AReturns depend mainly on the recovery value and timing under the absolute priority rule, and are largely independent of the overall equity marketCorrect
  2. BReturns are determined by coupon payments, since bondholders cannot be affected by the restructuring
  3. CEquity holders are paid before senior secured creditors if the firm is reorganized
  4. DReturns are driven only by the firm's credit rating at the time of purchase

Explanation

Distressed returns hinge on the value of the reorganized firm, the claim's position in the priority ladder, and the time to resolution. Senior secured claims rank ahead of equity. Coupons are often suspended and ratings are already low, so the other statements are wrong.

Did you get it right without looking?

One question tells you little. A timed set on Hedge Fund Investment Strategies shows your real accuracy, how long you take and where you lose marks.

Practise Hedge Fund Investment StrategiesFree diagnostic mock

More Hedge Fund Investment Strategies questions