Debt Capital Markets puzzles, solved step by step

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  1. 019A bank lent Rs 400 crore secured on a plant now worth Rs 250 crore. Unsecured bonds are Rs 300 crore and trade creditors Rs 100 crore. Other assets are worth Rs 200 crore. In a liquidation, what does the bank recover in total, and what do the bondholders get?Capital structure and recoveryCoreRestructuringCorporate banking

    Try it first

    What do the bondholders recover?

    Show the worked solution

    The bank recovers about Rs 304.5 crore, 76.1%; the bondholders get about Rs 109.1 crore, 36.4%. The bank takes the plant, Rs 250 crore, and is still owed Rs 150 crore. That shortfall ranks as an unsecured claim beside Rs 300 crore of bonds and Rs 100 crore of trade claims. The Rs 200 crore of other assets is shared across Rs 550 crore of claims at 36.36% each.

    What does security actually give the bank?

    A pawnbroker holding your watch gets the watch first. If the watch sells for less than you owe, you still owe the rest, but now as an ordinary debt. Security gives a lender first call on the pledged asset, up to its value; for any shortfall the lender becomes an ordinary unsecured creditor. Here the plant covers Rs 250 crore of the Rs 400 crore loan, so the bank is undersecuredOwed more than the value of the collateral pledged against the loan, so part of the claim is effectively unsecured. by Rs 150 crore.

    An undersecured lender takes its collateral, then joins the unsecured queueStage 1: the bank's own collateralplant 250short 150Bank claim 400joinsStage 2: 200 shared over 550 of unsecured claimsevery claim recovers 36.4%54.5claim 150Bank shortfall109.1claim 300Bonds36.4claim 100TradeBank: 250 + 54.5Rs 304.5 cr, 76.1%dashed outline = claim, filled = recovered, Rs crore
    The bank takes the Rs 250 crore plant and carries its Rs 150 crore shortfall into the unsecured pool, where Rs 200 crore of other assets is shared across Rs 550 crore of claims at 36.4%, giving the bank Rs 304.5 crore in total and the bondholders Rs 109.1 crore.

    How is the unsecured pool shared?

    Pro rata, by the size of each claim. All unsecured claims of the same rank share the unencumbered assets in proportion to what they are owed, and the bank's deficiency counts in full. The pool is 150 plus 300 plus 100, which is Rs 550 crore, against Rs 200 crore of assets, a recovery of 36.36%. The bank receives 36.36% of 150, Rs 54.5 crore, the bonds Rs 109.1 crore and trade creditors Rs 36.4 crore.

    The relationship
    ru=Aother(L−C)+B+T=200150+300+100=36.36%Bank=250+150×ru=304.5r_u = \frac{A_{\text{other}}}{(L - C) + B + T} = \frac{200}{150 + 300 + 100} = 36.36\% \qquad \text{Bank} = 250 + 150 \times r_u = 304.5
    r_urecovery rate on unsecured claims
    L - Cthe bank's loan less the collateral value, its deficiency
    B, Tbonds and trade claims
    A_otherassets not pledged to anyone, Rs 200 crore
    What it says in wordsUnsecured claims, including the secured lender's shortfall, share the free assets pro rata.

    What would change the numbers in a real case?

    Several things the puzzle strips out, and naming one or two shows judgement. Insolvency costs and any claims the law ranks ahead of unsecured creditors, such as some employee and statutory dues, come out of the pool first, so the real unsecured rate would be lower than 36.4%. Plant values in a forced sale are often below appraisal. And the priority rules differ by country and by process, so check the regime that applies. The core mechanics, collateral first and deficiency pari passu, hold widely.

    Where candidates lose it

    The first trap is ignoring the bank's shortfall, sharing Rs 200 crore over only the bonds and trade claims at 50%. That gives the bonds Rs 150 crore and quietly treats the bank as if its Rs 150 crore had vanished.

    The opposite slip is letting the bank take everything because it is the secured lender. Security attaches to the plant, not to every asset, so the other assets are shared.

    What the interviewer asks next

    • The plant sells for Rs 400 crore instead. What do the bondholders now recover?
    • The bank also holds a second charge on the other assets. How does that change the split?
    • Why would a bank lend against a plant knowing it might be worth less in a forced sale?
  2. 044A distressed bond trades at 55. It will either be repaid at 100 or restructured with a recovery of 30. Ignoring discounting, what probability of full repayment is the market pricing?Capital structure and recoveryCoreRestructuringCredit research

    Try it first

    The implied chance of full repayment is:

    Show the worked solution

    About 35.7%. Set the price equal to the probability-weighted payoff: p times 100 plus 1 minus p times 30 equals 55. The 30 is paid either way, so the price only has to cover 25 of the 70-point gap between recovery and par, and 25 over 70 is 35.7%. The market thinks restructuring is nearly twice as likely as repayment.

    How do you turn a price into a probability?

    Suppose a raffle ticket pays Rs 100 if you win and Rs 30 as a consolation prize if you lose, and it sells for Rs 55. Everyone gets the Rs 30, so you are really paying Rs 25 for a shot at an extra Rs 70. A price between two outcomes is a probability-weighted average of them, so you can solve for the weight. The consolation prize matters: ignore it and you would read the Rs 55 as a 55% chance.

    The relationship
    p⋅100+(1−p)⋅30=55  ⇒  p=55−30100−30=2570≈35.7%p \cdot 100 + (1 - p) \cdot 30 = 55 \;\Rightarrow\; p = \frac{55 - 30}{100 - 30} = \frac{25}{70} \approx 35.7\%
    pmarket-implied chance of full repayment
    100payoff if repaid in full
    30recovery if restructured
    55today's price
    What it says in wordsThe implied probability is how far the price sits above the recovery, as a share of the distance from recovery to par.
    The price tells you how far along the road from 30 to 100 the market sitsBond todayprice 55p = 35.7%1 - p = 64.3%Repaid in full100Restructuredrecovery 30305510025 of the 70 gapp x 100 + (1 - p) x 30 = 55 gives p = (55 - 30) / (100 - 30) = 25 / 70 = 35.7%
    A bond at 55 that pays either 100 or a recovery of 30 sits 25 points up a 70-point range, which implies a 35.7% chance of full repayment and a 64.3% chance of restructuring.

    What does ignoring discounting hide?

    Both payoffs arrive in the future, often a year or more away, and a distressed investor wants a high return for waiting. If the payoffs arrive in a year and the buyer demands 12%, the price must equal the expected payoff divided by 1.12, which lifts the implied repayment probability to about 45.1%. So the 35.7% is a floor: part of the discount to par is a charge for time and risk, not only for default. That is why desks quote these as risk-neutral probabilities, not forecasts.

    The other soft spot is the recovery of 30. It is an estimate, and the implied probability is sensitive to it: at a recovery of 40, p is 15 over 60, 25%. Before trading on the number, a credit analyst would test the recovery from the balance sheet and the claims ranking ahead of this bond.

    Where candidates lose it

    The instant wrong answer is 55%, reading the price as a probability. That would only be right if the bad outcome paid nothing. Here it pays 30, and the answer drops to 35.7%.

    The second miss is forgetting to say the assumption. Ignoring discounting makes the probability look low; one sentence noting that a required return would raise it shows you know the difference between a market price and a forecast.

    What the interviewer asks next

    • What price would imply a 50% chance of repayment?
    • If the recovery estimate falls to 20, what probability is implied at 55?
    • How would you set up the same calculation for a credit default swap spread?
  3. 062A company has an enterprise value of Rs 1,000 crore against senior secured debt of Rs 500 crore, senior unsecured debt of Rs 300 crore and subordinated debt of Rs 150 crore. Enterprise value then falls 30%. What does each layer recover, which layer is the fulcrum, and at what enterprise value would the equity start to be worth something?Capital structure and recoveryCoreKKRNew York · 2025

    Try it first

    After the fall, which layer is the fulcrum?

    Show the worked solution

    At Rs 700 crore, senior secured recovers 100%, senior unsecured 66.7% and the subordinated debt nothing, so the senior unsecured layer is the fulcrum. Value is paid down the stack in order: Rs 500 crore to the secured lenders leaves Rs 200 crore for Rs 300 crore of unsecured claims, and nothing below. The equity is worth something only once enterprise value exceeds total debt of Rs 950 crore.

    How is value shared out when it falls short of the debt?

    Picture water poured into a stack of glasses, each filling completely before any spills into the next. In a recovery, value pays each layer of the capital structure in full, in order of priority, before anything reaches the next layer down. The senior secured lenders' glass holds Rs 500 crore, the senior unsecured Rs 300 crore, the subordinated Rs 150 crore, and the equity takes whatever is left. Pour in Rs 700 crore and watch where it stops.

    Value fills the stack from the bottom; the fulcrum is where it runs outCoveredSenior securedRs 500 croreSenior unsecuredRs 300 croreSubordinatedRs 150 croreEquityEV 1,000, beforeEV 700, after the fallRecovery at Rs 700 crore100%66.7%: 200 of 300fulcrum0%equity also 0Claims, Rs crore, most senior at the bottom
    At Rs 700 crore of enterprise value, the Rs 500 crore senior secured layer is covered in full, the senior unsecured layer receives Rs 200 crore of its Rs 300 crore, 66.7%, and the subordinated debt and equity receive nothing, which makes senior unsecured the fulcrum.
    LayerClaimAt EV Rs 1,000 croreAt EV Rs 700 crore
    Senior secured500500 (100%)500 (100%)
    Senior unsecured300300 (100%)200 (66.7%)
    Subordinated150150 (100%)0 (0%)
    Equity500
    Total9501,000700
    Rs crore, recovery in brackets. At Rs 1,000 crore every debt layer is paid in full and the equity is worth Rs 50 crore; at Rs 700 crore the senior unsecured layer recovers 66.7% and everything below it is wiped out.

    Why does the fulcrum matter to a credit investor?

    The fulcrum securityThe most senior layer of the capital structure that the company value does not cover in full, so it is likely to receive the equity in a restructuring. is the layer where the value runs out. It usually ends up owning the business in a restructuring, because the layers above are paid in full and the layers below are wiped out. Here the senior unsecured lenders would likely exchange their Rs 300 crore of claims for most of the new equity. Distressed investors buy the fulcrum because its value moves most with the enterprise value: between Rs 500 and Rs 800 crore, every extra Rs 1 crore goes straight to it.

    At what value does the equity come back to life?

    The equity is out of the money until enterprise value covers every debt claim, Rs 500 plus 300 plus 150 crore, which is Rs 950 crore. At the original Rs 1,000 crore it was worth only Rs 50 crore, 5% of enterprise value, which is why a 30% fall wiped it out and went on through the subordinated layer too. The limit: this is a strict priority waterfall; in real restructurings junior classes often receive a small share to win their votes, and claims include accrued interest and fees, so treat these recoveries as the starting point of a negotiation.

    Where candidates lose it

    The common slip is sharing the loss pro rata: Rs 700 crore over Rs 950 crore of debt is 73.7% for everyone. That ignores priority, which is the whole point of a capital structure question.

    The second is naming the subordinated debt as the fulcrum because it is the first layer to lose everything. The fulcrum is the layer where the value line lands, the one that is only partly covered: here the senior unsecured.

    What the interviewer asks next

    • Enterprise value falls to Rs 450 crore. What does each layer recover now?
    • The senior secured lenders are also owed Rs 30 crore of accrued interest. Does the fulcrum move?
    • Where would the senior unsecured bonds trade if the market expects Rs 700 crore of value in a restructuring a year from now?

    Asked at KKR, Distressed Debt, New York, 2025 (Wall Street Oasis): What are your weaknesses? A capital structure question with enterprise value.