CFA Level I · CFA Level I Exam · Credit Risk
Two bonds are issued by the same company: a senior unsecured bond and a subordinated bond. Compared with the senior unsecured bond, the subordinated bond most likely has:
The subordinated bond most likely has a lower expected recovery rate and a higher yield spread. It ranks behind senior unsecured debt in the priority of claims, so losses in default are larger, and investors require extra compensation for that greater loss severity.
- Aa lower expected recovery rate and a higher yield spreadCorrect
- Ba higher expected recovery rate and a lower yield spread
- Ca lower expected recovery rate and the same yield spread
Explanation
Subordinated debt ranks below senior unsecured debt in the priority of claims, so its expected recovery in default is lower. Investors demand a higher spread to compensate for greater loss given default, even though both bonds share the same issuer.
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