CFA Level I · CFA Level I Exam · Credit Risk
Compared with a holding company's senior unsecured bonds, the senior unsecured bonds of its operating subsidiary most likely have a:
The operating subsidiary's senior unsecured bonds most likely have a higher recovery rate. Its creditors have a direct claim on the subsidiary's assets, whereas holding company creditors are structurally subordinated and can claim only what remains of the parent's equity interest in the subsidiary.
- Alower recovery rate because of structural subordination
- Bhigher recovery rate because creditors have a direct claim on the subsidiary's assetsCorrect
- Csimilar recovery rate because both are unsecured obligations of the same group
Explanation
Operating subsidiary creditors have a direct claim on the subsidiary's assets, while holding company creditors have only a residual claim through the parent's equity in the subsidiary. This structural subordination lowers holding company recovery relative to subsidiary creditors.
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