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FRM Part II · FRM Exam Part II · The Global Drivers of Private Credit

A credit analyst assesses a private equity-backed borrower with EBITDA of USD 50 million and total debt of USD 300 million. Interest is a floating rate of 11% on all debt. A sponsor argues the borrower can service its debt because EBITDA covers interest comfortably. What is the interest coverage ratio (EBITDA / interest), and what does it imply?

Interest equals 11% of USD 300 million, or USD 33 million. EBITDA of USD 50 million divided by 33 gives 1.52x. This thin coverage on floating-rate debt leaves the borrower vulnerable to higher rates or lower earnings, contradicting the sponsor's claim of comfort.

  1. A1.52x, which is thin and sensitive to further rate risesCorrect
  2. B0.66x, meaning EBITDA cannot cover interest
  3. C6.0x, which is very comfortable
  4. D3.03x, which is comfortable

Explanation

Interest = 11% x 300 = USD 33 million. Coverage = 50 / 33 = 1.52x. A thin cushion on floating-rate debt means a further rate rise or EBITDA drop can erode coverage. 0.66x inverts the ratio; 6.0x uses a wrong base (debt/EBITDA).

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