Explanation:
D is correct. The dollar default rate is calculated as the total par value of bonds that have defaulted in a given year divided by the total par value of all outstanding bonds. This measures the value impact of defaults rather than just the count of defaults.
Why other options are incorrect:
A is incorrect: Recovery rates follow a bimodal distribution, not a lognormal distribution with a single mode. The bimodal distribution arises due to different seniority levels among bonds from the same issuer.
B is incorrect: The issuer default rate measures the number of defaults in the entire market divided by the total number of issues outstanding. It is not specific to any individual issuer.
C is incorrect: Recovery rates are typically calculated as the value of the bond a few days after default as a percentage of its par value, not the post-liquidation amount. This is because tracking the actual amount eventually received by claimants is difficult and time-consuming.
Key Learning Points:
Ultimate access to all questions.
A risk manager on the corporate bond desk at an investment company is explaining the important metrics used to measure and manage the risks of bonds to a group of newly hired analysts. The manager describes the concepts of recovery rates and default rates. Which of the following statements is correct for the manager to make?
A
Recovery rates follow lognormal distribution with a single mode, shaped by differences in the seniority levels among bonds from the same issuer.
B
The issuer default rate relates the number of bonds that a specific issuer has defaulted on to the total number of bonds outstanding from this issuer.
C
Recovery rates used in financial analysis are typically calculated as the post-liquidation amount of principal retained by issuers.
D
The dollar default rate uses par values to measure the value of bonds that have defaulted as a percentage of the total value of outstanding bonds.
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