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FRM Part I · FRM Exam Part I · Corporate Bonds

Which statement about recovery rates on defaulted corporate bonds is most accurate?

Recovery rates tend to be negatively correlated with default rates, so recoveries are lower in recessions. This amplifies credit losses when defaults are most frequent. Senior debt recovers more than subordinated debt, and recovery equals one minus loss given default.

  1. ARecovery rates are typically negatively correlated with default rates, so recoveries tend to be lower in recessionsCorrect
  2. BRecovery rates are independent of default rates across the business cycle
  3. CSenior unsecured bonds usually have lower recovery rates than subordinated bonds
  4. DRecovery rate is defined as loss given default divided by exposure

Explanation

Empirical evidence shows recovery rates fall when default rates rise, increasing credit losses in downturns. Seniority raises recovery, not lowers it, and recovery equals one minus loss given default.

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