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

A mezzanine debt fund lends at 12% cash and PIK interest, ranking below senior debt. Relative to senior secured loans, mezzanine debt most likely has:

Mezzanine debt most likely has higher expected loss given default and higher expected return than senior secured loans. Its subordinated claim means lower recoveries in default, which investors are paid for through higher coupons, PIK interest and sometimes equity features.

  1. Ahigher expected loss given default and higher expected returnCorrect
  2. Blower recovery risk because of its junior claim
  3. Clower interest rate sensitivity because it ranks below equity

Explanation

Mezzanine debt is subordinated to senior debt, so recoveries in default are lower and loss given default is higher. Investors are compensated with higher yields and often equity kickers. It ranks above equity, not below, and junior status raises recovery risk.

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