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Answer: If the corporate issuer defaults on the bond, the value of the bond shortly after default is expected to equal 35% of the bond's par value.
## Explanation **Recovery Rate Definition**: Recovery rate is defined as the percentage of a bond's face value that investors can expect to recover after a default occurs. It is typically expressed as a percentage of the bond's par value. **Analysis of Options**: - **Option A**: Incorrect - Recovery rate is based on the bond's **face value** (par value), not the initial purchase price. The initial purchase price could be above or below par, so this would not represent a standard recovery rate definition. - **Option B**: Incorrect - If the recovery rate is 35%, the bank would take possession of collateral valued at **35%** of the bond's face value, not 65%. The 65% represents the loss given default (LGD), which equals 1 - recovery rate. - **Option C**: Incorrect - This describes **probability of default** (65%), not recovery rate. Recovery rate and probability of default are distinct concepts in credit risk analysis. - **Option D**: **CORRECT** - This accurately describes recovery rate as the value of the bond shortly after default expressed as a percentage of the bond's par value. A 35% recovery rate means investors can expect to recover 35% of the bond's face value after default. **Key Concept**: Recovery rate = Value after default / Face value × 100% Loss given default (LGD) = 1 - Recovery rate = 65% in this case
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Which of the following would the trader be correct to identify as an example of a corporate bond that is held by the bank and has a recovery rate of 35%?
A
If the corporate issuer becomes insolvent, liquidation of the issuer's assets would result in the bank receiving 35% of the price it initially paid for the bond.
B
If the corporate issuer defaults on a collateralized bond, the bank would take possession of an amount of collateral valued at 65% of the bond's face value.
C
At the time the bank purchases the bond, there is a 65% unconditional probability that the corporate issuer will not make full and timely payments on the bond.
D
If the corporate issuer defaults on the bond, the value of the bond shortly after default is expected to equal 35% of the bond's par value.
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