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FRM Part I · FRM Exam Part I · Corporate Bonds

Two bonds from the same issuer have equal maturities and coupons. Bond S is senior secured; Bond J is junior subordinated. Which outcome is most consistent with standard corporate bond features?

Bond J should offer a higher yield and have a lower expected recovery. Subordinated claims rank behind senior secured claims in bankruptcy, so investors demand extra spread for bearing greater loss given default.

  1. ABond J offers a higher yield and has lower expected recovery in defaultCorrect
  2. BBond S offers a higher yield because its collateral reduces liquidity
  3. CBoth have the same expected recovery because the issuer is the same
  4. DBond J has higher recovery because junior bonds are repaid first in liquidation

Explanation

Priority determines recovery: senior secured claims are paid before subordinated ones, so J has lower expected recovery and so requires a higher spread. Same issuer does not imply same recovery because recovery depends on seniority. Junior claims are paid last, not first.

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