FRM Part I · FRM Exam Part I · Corporate Bonds
A portfolio manager observes that a senior unsecured bond has a one-year default probability of 3% and a loss given default of 55%. The same issuer's subordinated bond has the same default probability but a recovery rate of 15%. What is the difference in one-year expected loss rate (as a percentage of exposure) between the subordinated and senior bonds?
The difference is 0.90 percentage points, since the subordinated bond loses 2.55% and the senior bond loses 1.65%.
- A0.30 percentage pointsCorrect
- B0.45 percentage points
- C1.65 percentage points
- D2.55 percentage points
Explanation
Senior LGD = 55%, so expected loss = 0.03 x 0.55 = 1.65%. Subordinated LGD = 85%, so expected loss = 0.03 x 0.85 = 2.55%. Difference = 0.90 percentage points. This is not among the options as written, so check: 2.55 - 1.65 = 0.90. The correct choice must be 0.90, but it is absent; the 0.30 option is wrong.
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