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FRM Part II · FRM Exam Part II · Private Markets Investing

A direct lending portfolio has 50 USD 10 million loans, an annual default probability of 4%, and LGD of 40%. Defaults are assumed independent. The fund management fee is 1.0% of the USD 500 million portfolio and gross portfolio yield is 9.0%. Ignoring other costs, what is the expected net return after expected credit losses and fees?

Net return is 6.40%. Expected credit loss is the 4% default probability times 40% loss given default, or 1.6%. Subtracting this and the 1.0% fee from the 9.0% gross yield gives 6.4%.

  1. A6.40%Correct
  2. B7.40%
  3. C8.00%
  4. D5.40%

Explanation

Expected loss = 4% x 40% = 1.6% of the portfolio. Net = 9.0% - 1.6% - 1.0% = 6.4%. Omitting the fee gives 7.4%; omitting the loss gives 8.0%; subtracting 4% x 100% LGD wrongly gives 4.0%, and the 5.4% option subtracts 2.6%.

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