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

A fund holds the fulcrum security in a restructuring, where the enterprise value of USD 500 million is allocated as follows: first-lien loans of USD 200 million, second-lien notes of USD 400 million, and unsecured notes of USD 300 million. The fund also considers a position in each class bought at prices of 100, 50 and 10 respectively. Which statement is most accurate?

The second-lien notes are the fulcrum security. After the USD 200 million first-lien claim, only USD 300 million remains against USD 400 million of second-lien claims, so value runs out there. That class is impaired, typically receives the new equity, and holders gain influence over the restructuring.

  1. AThe second-lien notes are the fulcrum security, because value runs out within that class and it will likely receive the reorganized equityCorrect
  2. BThe first-lien loans are the fulcrum security because they are the most senior
  3. CThe unsecured notes are the fulcrum security because they are the cheapest
  4. DThere is no fulcrum security because enterprise value exceeds first-lien claims

Explanation

First-lien takes 200, leaving 300 against second-lien claims of 400, so value is exhausted in the second-lien class (75% recovery). That class is the fulcrum and typically converts to control of the reorganized equity. Unsecured notes get nothing, and first-lien is paid in full.

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