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

A distressed investor buys a bond with face value of $1,000,000 at 40 cents on the dollar. After restructuring, the investor receives new debt with a market value of $350,000 and equity with a market value of $150,000. Ignoring interest and costs, what is the investor's total return on the investment?

The investor paid $400,000 and received securities worth $500,000, so the gain is $100,000 on a $400,000 cost, a 25% return. The 50% figure is the recovery rate on face value, not the return on the purchase price.

  1. A25.0%Correct
  2. B50.0%
  3. C25.0% loss
  4. D10.0%

Explanation

Cost = 0.40 x 1,000,000 = $400,000. Value received = 350,000 + 150,000 = $500,000. Return = (500,000 - 400,000)/400,000 = 25.0%. The 50% figure wrongly uses the recovery against face value (500,000/1,000,000 = 50% recovery) as the return.

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