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CFA Level I · CFA Level I Exam · Credit Risk

Two senior unsecured bond issuers have identical cash flow coverage. Issuer X has substantial unencumbered assets, and Issuer Y has assets that are largely pledged to secured lenders. In a credit analysis focused on collateral, which conclusion is most appropriate?

Issuer X's unsecured creditors likely have stronger recovery prospects. Unencumbered assets are available to satisfy unsecured claims, while Y's pledged assets go first to secured lenders. Collateral mainly influences loss given default, so the two issuers should not be assessed equally.

  1. AIssuer X's unsecured creditors likely have stronger recovery prospects, supporting a higher assessmentCorrect
  2. BIssuer Y's unsecured creditors are favored because pledged assets signal lender confidence
  3. CCollateral affects only the probability of default, so the two are assessed equally

Explanation

Collateral concerns asset quality and the claims on those assets, which mainly affect loss given default. Pledged assets go first to secured lenders, leaving less for Y's unsecured creditors. X's unencumbered assets improve unsecured recovery. Collateral does not affect only default probability.

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