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FRM Part I · FRM Exam Part I · Corporate Bonds

In a bankruptcy, a firm has the following debt classes: senior secured, senior unsecured, subordinated, and junior subordinated. Based on the absolute priority rule, which ordering of expected recovery rates, from highest to lowest, is most consistent with bond seniority?

Expected recovery falls from senior secured to senior unsecured to subordinated to junior subordinated. Absolute priority requires more senior claims to be paid in full before junior claims receive anything, so more senior bonds recover more on average after default.

  1. ASenior secured, senior unsecured, subordinated, junior subordinatedCorrect
  2. BSenior unsecured, senior secured, junior subordinated, subordinated
  3. CJunior subordinated, subordinated, senior unsecured, senior secured
  4. DSenior secured, subordinated, senior unsecured, junior subordinated

Explanation

Absolute priority pays claims in order of seniority, with secured creditors first from collateral, then unsecured, then subordinated classes. Expected recoveries therefore decline in that order. The reverse ordering inverts seniority.

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