Skip to content

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

A fund evaluates two distressed bonds of the same issuer: Bond X is senior unsecured and Bond Y is subordinated. Value available to unsecured and junior classes is $240 million. Senior unsecured claims are $200 million and subordinated claims are $100 million. Bond X trades at 85 and Bond Y at 30, both per 100 of face. Under absolute priority, which statement is correct?

Senior unsecured creditors are paid in full from the $240 million, recovering 100, leaving $40 million for $100 million of subordinated claims, a 40 recovery. Bond Y at 30 offers a 33% upside versus about 18% for Bond X at 85, so Y has the larger percentage upside.

  1. ABond X expected recovery is 100 and Bond Y is 40, so Bond Y is cheaper relative to expected recovery, with Bond Y offering the larger percentage upsideCorrect
  2. BBond X expected recovery is 100 and Bond Y is 40, so Bond X offers the larger percentage upside
  3. CBond X expected recovery is 80 and Bond Y is 40, so both are overpriced
  4. DBond X expected recovery is 120 and Bond Y is 0

Explanation

Senior unsecured is paid 200 in full (recovery 100). The remaining 40 goes to subordinated claims of 100, a recovery of 40. Upside for X is 100/85 - 1 = 17.6%; for Y is 40/30 - 1 = 33.3%. Y offers greater percentage upside, though with more valuation risk.

Did you get it right without looking?

One question tells you little. A timed set on Distress Symptoms and Remedies shows your real accuracy, how long you take and where you lose marks.

Practise Distress Symptoms and RemediesFree diagnostic mock

More Distress Symptoms and Remedies questions