Bond Recovery After Default: Coupon Accrual and Accelerated Principal
Summary
The document asks how to apply a recovery rate when a coupon bond defaults before its first coupon payment. The answers describe a common developed-market convention: unpaid accrued coupon is generally lost, while the remaining principal becomes due immediately. Under that convention, recovery is based on the current face amount, including any amortization, rather than future coupons or the bond’s original maturity.
The responses distinguish ordinary bonds from bespoke credit-linked notes. A note’s terms can specify different treatment, such as accruing coupon through the default date or linking recovery to interest rates, so the contract controls where it departs from convention. One answer also notes that the timing of the recovery payment may vary. The discussion gives a general convention, not a universal rule for every market or instrument; contractual terms and applicable market practice need to be checked.
Key ideas
- A common convention excludes unpaid accrued coupon from bond recovery.
- Principal may be accelerated at default, with recovery calculated on the current face amount.
- Amortization affects the remaining principal used for recovery.
- Credit-linked instruments can specify different coupon accrual or recovery terms.
- Recovery payment timing can vary.
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Full text
# Bond recovery rate with coupon # Bond recovery rate with coupon Suppose a bond has annual coupon of \$1 and face value of \$100 and matures in two years. If recovery rate is $50\%$ and the bond defaults before the first coupon payment. How should we receive the recovery? Is it \$50 at year 2 or \$0.5 at year 1 and \$100.5 at year 2? ## Answer by Dimitri Vulis (score 2) https://quant.stackexchange.com/a/43336 Generally, the developed markets convention is that all the coupon that has been accrued and not paid yet just disappears, but the remaining notional is accelerated - becomes due immediately. To illustrate, suppose for concreteness that the issuer has two bonds. One pays 6% coupon, and matures in 2 years, bullet. The other pays 7% coupon, matured in 10 years, and has amortized, so the current factor is 75%. If the issuer defaults, then the coupons don't matter, the maturities don't matter. The current interest rate levels don't matter. The recovery is on face value of the bullet bond and 75% of face value of the amortized bond. Now, if instead of a bond you issue a bespoke credit-linked note, then you can specify anything you like on the term sheet. In particular, you can say that in case of a credit event, the coupon accrues until the day of default (like running spread of a credit default swap). You can also link the recovery to interest rates in some way. Although this is very seldom done, a good analytics library should have the flexibility to support this. ## Answer by Will Gu (score 1) https://quant.stackexchange.com/a/39092 the recovery rate is of the par value, which is \$100 in your case. So you'd receive \$50 in case of default. The time of receiving the recovery value could vary.
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