Sludge Corporation has two bonds outstanding, each with a face value of $3.00 million. Bond A is a senior bond; bond B is subordinated. Sludge has suffered a severe downturn in demand, and its assets are now worth only $5.00 million. If the company defaults, what payoff can the holders of bond B expect

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Business

Omar

21 January, 19:25

Sludge Corporation has two bonds outstanding, each with a face value of $3.00 million. Bond A is a senior bond; bond B is subordinated. Sludge has suffered a severe downturn in demand, and its assets are now worth only $5.00 million. If the company defaults, what payoff can the holders of bond B expect

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Moriah Chavez · Answer 1

The payoff for holders of Bond B is $2,000,000

Explanation:

The senior bond takes priority over the subordinated bond when it comes redeeming bondholders investment in the business.

The senior bond has a lower risk as it is paid first in the event of liquidation, though attracts a lower rate of return since return and risk are positive related.

The subordinated is ranked lower than the senior debt but may command a higher rate of return because of its high risk.

Assets worth $5,000,000

repayment of senior debt ($3,000,000)

Balance left for subordinated debt $2,000,000