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

A private credit fund has USD 400 million of equity and borrows USD 600 million, investing USD 1,000 million in loans yielding 9.0%. Borrowing costs 6.0%. Ignoring fees and defaults, what is the return on equity?

Return on equity is 13.5%. Loans earn 90 million on 1,000 million, borrowing costs 36 million on 600 million, leaving 54 million of net income on 400 million of equity. Leverage of 1.5 times debt to equity magnifies the 3% spread to add 4.5% above the 9% asset yield.

  1. A9.0%
  2. B13.5%Correct
  3. C15.0%
  4. D22.5%

Explanation

Interest income is 1,000 x 9% = 90. Interest expense is 600 x 6% = 36. Net income is 54, and 54/400 = 13.5%. Option C results from ignoring that borrowing cost applies to debt only on the spread: 3% x 1.5 + 9% = 13.5 is correct, while 15% omits part of the cost. Check: 9% + 1.5 x 3% = 13.5%.

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