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FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies

A distressed investor buys $10 million face of senior unsecured bonds at 40 cents on the dollar. The investor expects the reorganization to produce a recovery of 65 cents on the dollar, received one year after purchase, with no coupons. What is the expected one-year return on the investment?

The expected return is 62.5%. The investor pays $4.0 million for the bonds and expects $6.5 million in recovery, so the gain of $2.5 million divided by the $4.0 million cost equals 62.5%.

  1. A25.0%
  2. B62.5%Correct
  3. C38.5%
  4. D65.0%

Explanation

Cost = 0.40 x 10m = $4.0m. Recovery = 0.65 x 10m = $6.5m. Return = (6.5 - 4.0)/4.0 = 62.5%. The 25.0% option is the price gain in cents (25 points) mistaken for a percent return; 65% uses recovery divided by face.

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