CFA Level I Exam · Investments in Private Capital: Equity and Debt

Private Debt Types and Characteristics for CFA Level I

Updated 7 October 2026 · Fact-checked

Private debt is lending that is negotiated directly with borrowers and not traded on public markets. Main types are direct lending, unitranche, mezzanine, venture debt and distressed debt. To answer exam questions, place each type on the capital structure, then match seniority, yield, collateral and risk to the stem.

Understand Private Debt Types and Characteristics

Private debt is credit extended outside public bond markets. A lender, often a fund, negotiates terms directly with the borrower. Loans are usually illiquid, held to maturity, and customized through covenants, pricing and structure. Many pay floating rates, so income moves with a reference rate plus a spread.

Think of the borrower's capital structure as a ladder. Senior secured debt sits at the top and is repaid first. Subordinated debt sits lower. Equity sits at the bottom. The lower a lender sits, the more risk it takes, so it generally demands a higher return. Most private debt types are just different rungs on this ladder.

Direct lending means a fund lends straight to mid-sized companies, often those owned by private equity sponsors. Loans are usually senior secured and floating rate. Unitranche blends senior and subordinated debt into one loan with one blended interest rate and one lender or lender group. It is simpler and faster for the borrower, but the blended rate sits above pure senior and below pure mezzanine.

Mezzanine debt is subordinated to senior debt but ranks ahead of equity. It often pays a higher coupon, part of which may be paid in kind (PIK), meaning interest is added to principal. It may also carry equity kickers such as warrants. Venture debt is lent to early-stage, venture-backed companies that lack the cash flow for ordinary bank loans. It is often paired with warrants, and lenders rely on the backing of equity investors and on the company's ability to raise further funding.

Distressed debt is the debt of companies in or near financial distress or bankruptcy. Investors buy at a deep discount to face value. Returns come from recovery in restructuring, a turnaround, or gaining influence or control through a debt-for-equity swap. Risk is high and outcomes are uncertain. Strategies can be passive, buying and waiting, or active, where the investor takes part in the restructuring.

Key formulas to remember

Capital structure priority: Senior secured > Mezzanine/subordinated > Equity, with unitranche spanning senior and subordinated risk; Lower priority generally means higher risk and higher expected yield, though not always. Unitranche is one loan that blends senior and junior features, so it is not a separate priority rung. Its yield sits between pure senior and mezzanine.
Floating-rate loan coupon: Coupon rate = Reference rate + Credit spread; Typical for direct lending. Income rises when the reference rate rises.
PIK interest: New principal = Old principal × (1 + PIK rate); Interest is added to principal instead of paid in cash, so cash flow is deferred and risk at maturity increases.
Distressed debt return on purchase: Return = (Recovery value − Purchase price) ÷ Purchase price; Ignoring interim cash flows. Recovery value is uncertain and is the key risk.

How to solve Private Debt Types and Characteristics questions

Use this approach for any question on private debt types.

1Identify the borrower's profile: stable mid-sized firm, early-stage venture-backed firm, or financially distressed firm.
2Locate the instrument on the capital structure: senior, blended, subordinated, or claim in default.
3Match the type: direct lending (senior, floating), unitranche (single blended loan), mezzanine (subordinated, PIK or warrants), venture debt (early stage, warrants), distressed (discounted debt of troubled issuer).
4Link position to risk and return: lower rung generally means higher yield, weaker recovery and more equity-like features.
5Check liquidity and structure details such as covenants, collateral, floating rates and holding period.
6Eliminate the two options that contradict seniority, borrower profile or return source, then choose the remaining one.

Quickest way: Borrower-plus-rung shortcut

When to use it: Use when the stem gives a short description and asks which type or which feature applies.

Underline the borrower type and any words like subordinated, warrants, blended, discount or bankruptcy.
Map keywords: blended means unitranche, warrants with early-stage firm means venture debt, PIK or subordinated means mezzanine, deep discount means distressed.
Rank risk by rung and discard options that reverse it, such as senior debt offering the highest yield.

Common mistakes in Private Debt Types and Characteristics

Treating unitranche as the same as mezzanine
A unitranche yield sits above pure senior and below mezzanine, and it includes junior risk, so it looks similar to mezzanine.
Fix: Unitranche is one loan blending senior and junior risk with a single rate. Mezzanine is a separate subordinated layer behind senior debt.
Assuming all private debt is subordinated and high risk
Students link private with risky.
Fix: Direct lending is typically senior secured. Risk depends on the rung and the borrower.
Thinking distressed debt investors earn mainly coupons
Debt is associated with interest income.
Fix: Distressed returns mainly come from buying at a deep discount and recovering value through restructuring, turnaround or conversion.
Confusing PIK interest with cash interest
The word interest suggests a cash payment.
Fix: PIK is added to principal. It preserves borrower cash but raises the balance owed and the risk at maturity.
Believing venture debt is repaid from the company's profits
Ordinary loans rely on earnings.
Fix: Venture borrowers are often loss-making. Lenders rely on equity investor backing, further fundraising and any collateral, and use warrants to add upside.
Assuming private debt is liquid like public bonds
Both are debt instruments.
Fix: Private loans are negotiated, rarely traded and usually held to maturity, so expect an illiquidity premium.

Worked examples

Example 1

A fund lends to a mid-sized company in a single loan that combines senior and subordinated risk, with one blended interest rate and one lender or lender group. Compared with a pure senior loan to the same company, the unitranche loan most likely has:
A. a lower yield and stronger priority of claims
B. a higher yield and weaker priority of claims overall
C. a yield equal to pure senior debt with identical priority

Show the solution

Identify the type: one loan, one blended rate, one lender or lender group means unitranche.
A unitranche includes junior risk, so its overall priority is weaker than pure senior debt.
Weaker priority means investors require higher yield than pure senior.
Option A reverses the relationship. Option C ignores the junior risk in the blend, so it cannot match pure senior debt.

Answer: B. Higher yield and weaker overall priority than a pure senior loan.

Example 2

An investor buys the bonds of a company in bankruptcy proceedings at 40 per 100 of face value. After restructuring, the investor receives securities worth 70 per 100 of face value. Ignoring interim cash flows, the return is closest to:
A. 30.0%
B. 42.9%
C. 75.0%

Show the solution

Return = (Recovery value − Purchase price) ÷ Purchase price.
Gain = 70 − 40 = 30.
Return = 30 ÷ 40 = 0.75, or 75.0%.
Option A is 30 ÷ 100, which divides by face value instead of purchase price.
Option B is 30 ÷ 70, which divides by recovery value instead of purchase price.

Answer: C. 75.0%. The return is measured on the discounted purchase price, not the face value or recovery value.

Exam tips

Match the borrower profile to the type first. Early stage means venture debt, troubled issuer means distressed, sponsor-backed mid-sized firm means direct lending or unitranche.
Remember the general rule: lower on the capital structure means higher expected return and higher risk.
Watch for distractors that give senior secured loans the highest yield or distressed debt a stable coupon income.
For distressed returns, divide by the purchase price. Use your calculator carefully and check the answer is in the ordered options.
Expect liquidity, covenant and floating-rate features in conceptual questions. Private debt is illiquid and usually held to maturity.

Practice questions from Investments in Private Capital: Equity and Debt

Private Debt Types and Characteristics in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Private Debt Types and Characteristics: frequently asked questions

What is the difference between mezzanine debt and senior debt?

Senior debt is repaid first and is usually secured, so it has lower risk and lower yield. Mezzanine debt is subordinated, ranks behind senior debt, and often pays a higher coupon with PIK interest or warrants. In default, mezzanine lenders recover only after senior lenders are paid.

What is unitranche debt?

Unitranche is a single loan that blends senior and subordinated debt into one facility with one blended rate. The borrower deals with one lender or lender group, which makes execution simpler. The blended rate sits between pure senior and mezzanine pricing.

How do distressed debt investors make money?

They buy the debt of troubled companies at a deep discount. Gains come from recovery in restructuring, a successful turnaround, or converting debt into equity. The risk is high because recovery is uncertain.

Why does venture debt include warrants?

Venture borrowers are early stage, so default risk is high and interest alone may not compensate the lender. Warrants give the lender a share of the upside if the company succeeds, adding return beyond the interest.