FRM Part I · FRM Exam Part I · Corporate Bonds
Which statement about recovery rates on defaulted corporate bonds is most consistent with empirical evidence?
Empirically, senior secured debt recovers more than junior unsecured debt, and recovery rates fall when default rates rise, because asset values decline in downturns. This negative correlation raises losses in bad times and means assuming constant recovery understates credit risk.
- ARecovery rates tend to be lower for junior unsecured debt than for senior secured debt, and tend to fall when default rates are highCorrect
- BRecovery rates are independent of seniority and collateral
- CRecovery rates are typically higher in recessions because of asset sales
- DRecovery rates are negatively correlated with default rates only for investment-grade issuers
Explanation
Seniority and collateral raise recoveries, and recoveries are negatively correlated with aggregate default rates, since distressed asset values fall together in downturns. The other options contradict this evidence.
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