Skip to content

FRM Part II · FRM Exam Part II · The Rise and Risks of Private Credit

A pension fund holds a direct-lending fund whose loans have no quoted market prices. The manager reports net asset value using internal models updated quarterly, and the reported NAV shows very low volatility compared with listed leveraged loans. Which risk is most directly implied by relying on these reported values?

Valuation risk is the main concern. Private loans lack observable prices, so managers use internal models and infrequent updates, which smooth returns. Reported volatility and drawdowns therefore look lower than the true economic risk, which can mislead investors about the actual risk of the fund.

  1. AValuation risk, because smoothed model-based marks can understate true volatility and drawdownsCorrect
  2. BReinvestment risk, because the loans will be repaid early at par
  3. CSettlement risk, because trades fail to deliver on the payment date
  4. DBasis risk, because the loans are hedged with futures

Explanation

Infrequent, model-based marks of unlisted loans tend to smooth returns, so measured volatility and correlations with public markets are understated. This is valuation risk. The other options describe risks unrelated to the use of stale or modeled prices.

Did you get it right without looking?

One question tells you little. A timed set on The Rise and Risks of Private Credit shows your real accuracy, how long you take and where you lose marks.

Practise The Rise and Risks of Private CreditFree diagnostic mock

More The Rise and Risks of Private Credit questions