FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies
A fund buys senior unsecured bonds of a distressed issuer with face value of USD 10 million at a price of 40. The fund estimates that in reorganization the bonds will recover 65 cents on the dollar, received in one year. Ignoring coupons, costs and discounting, what is the expected gain as a percentage of the purchase cost?
The fund pays USD 4 million for bonds that recover USD 6.5 million, a gain of USD 2.5 million. Dividing by the USD 4 million cost gives a return of 62.5%. Measuring the gain against face value instead would understate the return.
- A25.0%
- B62.5%Correct
- C37.5%
- D65.0%
Explanation
Cost = 10m x 0.40 = USD 4.0m. Recovery = 10m x 0.65 = USD 6.5m. Gain = 2.5m, and 2.5/4.0 = 62.5%. The 25.0% figure wrongly divides by face value or subtracts the price points without scaling by cost.
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