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

A hedge fund analyst is reviewing a bankrupt manufacturer. The fund holds a senior secured term loan. Under the absolute priority rule in a Chapter 11 plan, which statement best describes how value should be distributed?

Under the absolute priority rule, senior secured creditors are paid first up to their collateral value, then unsecured creditors, and equity holders receive value last. Junior classes get nothing until senior classes are satisfied in full.

  1. ASenior secured claims are satisfied up to the value of their collateral before junior unsecured creditors receive anything, and equity holders are paid lastCorrect
  2. BEquity holders and unsecured creditors share pro rata in all distributable value regardless of seniority
  3. CUnsecured creditors are paid before secured creditors if their claims are larger
  4. DValue is distributed equally across all creditor classes in proportion to claim size

Explanation

Absolute priority requires that more senior classes be paid in full (up to collateral value for secured claims) before junior classes receive value, and equity is the residual claimant. The other options ignore seniority ranking.

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