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

A pension fund is comparing two private equity strategies. Strategy X invests in early-stage companies with no operating revenue and funds them in staged rounds. Strategy Y acquires mature, cash-generating companies using a large proportion of borrowed funds. Which statement correctly identifies the strategies and their typical primary source of value creation?

Strategy X is venture capital, with value coming from growth and commercialization of young companies. Strategy Y is a leveraged buyout of mature, cash-generating firms, with value coming from operational improvements, debt paydown and multiple expansion. Venture capital uses little debt, while buyouts rely heavily on it.

  1. AX is venture capital, relying mainly on growth and successful commercialization; Y is a leveraged buyout, relying on operational improvement, debt paydown and multiple expansionCorrect
  2. BX is a leveraged buyout, relying mainly on financial engineering; Y is venture capital, relying on commercialization of new technology
  3. CX is venture capital, relying mainly on high leverage to magnify returns; Y is a leveraged buyout, relying on technology breakthroughs
  4. DX is a growth buyout, relying on dividend recapitalizations; Y is venture capital, relying on cost cutting

Explanation

Early-stage, pre-revenue companies financed in rounds describe venture capital, whose returns depend on growth and commercialization. Mature, cash-generating targets bought with substantial debt describe leveraged buyouts, where value comes from operational improvement, debt paydown and multiple expansion. The other options swap the strategies or attribute leverage to venture capital.

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