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

A private credit fund holds loans with total par of USD 500 million, financed by USD 200 million of fund-level borrowing. Equity is therefore USD 300 million. Loans are floating-rate; borrowers' interest coverage deteriorates after a rate rise and the fund marks the portfolio down 6% on par. What is the percentage decline in fund equity, and what does it illustrate?

Equity falls 10%. A 6% markdown on USD 500 million is a USD 30 million loss, which falls entirely on equity of USD 300 million because the USD 200 million of debt is fixed. Leverage of 1.67 times magnifies the portfolio loss.

  1. A6%, showing leverage has no effect on marks
  2. B10%, showing leverage amplifies valuation losses on equityCorrect
  3. C12%, because losses are shared with lenders
  4. D20%, showing the loss is applied to debt only

Explanation

Portfolio loss = 6% x 500 = USD 30 million. Debt is fixed at 200, so equity falls from 300 to 270, a 10% decline. Check: leverage 500/300 = 1.667; 6% x 1.667 = 10%. Leverage magnifies losses on the equity.

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