CFA Level I · CFA Level I Exam · Credit Analysis for Corporate Issuers
An analyst compares two bonds from the same corporate issuer with the same maturity, one senior unsecured and one subordinated. Holding all else constant, the subordinated bond is most likely to trade with a:
The subordinated bond most likely trades at a wider credit spread. Although the issuer's default probability is the same, subordinated creditors expect lower recovery in default, so expected loss is higher and investors demand more compensation than for the senior unsecured bond.
- Awider credit spread because of lower recovery expectationsCorrect
- Bnarrower credit spread because of higher coupon rates
- Csimilar credit spread because the issuer's default probability is the same
Explanation
Seniority affects recovery given default. Subordinated debt ranks below senior unsecured debt, so expected loss is higher and investors require a wider spread. Equal default probability does not imply equal spreads because loss given default differs.
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