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

A pension fund is comparing two private equity strategies. Strategy A invests in young, pre-revenue technology companies using mostly equity funding. Strategy B acquires mature, cash-generating companies using substantial borrowed funds secured on the target's cash flows. Which statement correctly characterizes the two strategies?

Strategy A is venture capital, funding young companies with equity and producing skewed returns driven by a few big winners. Strategy B is a leveraged buyout, buying mature cash-generative firms with heavy debt, where returns come from debt paydown, operational improvement and valuation changes.

  1. AA is venture capital, with outcomes dominated by a few large winners; B is a leveraged buyout, where returns rely on debt paydown and operational improvementCorrect
  2. BA is a leveraged buyout, with returns driven by debt paydown; B is venture capital, with outcomes dominated by a few large winners
  3. CBoth are venture capital, differing only in the stage of the investee companies
  4. DBoth are leveraged buyouts, differing only in the size of the target

Explanation

Venture capital funds early-stage companies with little debt and skewed payoffs where a few winners drive returns. Leveraged buyouts target mature firms with stable cash flows and use debt, with returns from deleveraging, operational gains and multiple expansion. The swapped labels in the other options reverse these features.

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