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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 **D is correct.** The recovery rate for a bond is defined as the value of the bond shortly after default, expressed as a percentage of its face (par) value. This represents the amount the lender can expect to recover if the firm defaults. **Why other options are incorrect:** - **A is incorrect:** This describes receiving 35% of the initial purchase price, not the face value. Recovery rate is based on par value, not purchase price. - **B is incorrect:** This describes collateral valued at 65% of face value, which would imply a 65% recovery rate, not 35%. - **C is incorrect:** This describes a 65% probability of default, which is about default probability, not recovery rate. Recovery rate is a conditional measure (given default occurs) and is not an unconditional probability. **Key Concept:** Recovery rate = Value after default ÷ Face value × 100%
Author: LeetQuiz .
A senior trader on the fixed-income trading desk of an investment bank is presenting to a group of newly hired analysts on key drivers of credit risk. The trader illustrates the concept of recovery rates using a scenario of a bank buying a corporate bond. 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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