FRM Part II · FRM Exam Part II · The Global Drivers of Private Credit
A fund holds USD 400 million of loans funded with USD 100 million equity and USD 300 million of bank borrowing. Loan losses of 10% occur with no other income or cost changes. What are the loss as a percentage of equity and the resulting leverage effect?
The loss is USD 40 million, which is 40% of the USD 100 million equity. Leverage of four times assets to equity magnifies the 10% asset loss into a 40% equity loss, leaving equity at USD 60 million.
- A10% of equity, no leverage effect
- B30% of equity
- C40% of equity, wiping out less than all equityCorrect
- D75% of equity
Explanation
Loss is 10% x 400 = 40 million. Relative to equity of 100 million that is 40%, so equity falls to 60 million. Ignoring leverage gives 10%, while 30% wrongly uses debt as the base, and 75% has no basis.
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