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CFA Level I · CFA Level I Exam · Investments in Private Capital: Equity and Debt

A private debt fund lends EUR 100 million at a fixed 9% annual rate. Over the year, loans representing 5% of the portfolio default, with a recovery rate of 40% on the defaulted principal. Ignoring fees, interest on defaulted loans and reinvestment, the portfolio's net return for the year, assuming interest is earned on the full EUR 100 million, is closest to:

The net return is about 6.0%. Interest earns EUR 9 million on EUR 100 million. Defaults of EUR 5 million with 40% recovery cause a loss of EUR 3 million. Subtracting the loss from interest leaves EUR 6 million, or 6.0% of the portfolio.

  1. A3.0%
  2. B6.0%Correct
  3. C9.0%

Explanation

Interest income = 9% × 100 = EUR 9.0 million. Defaulted principal = 5 million; recovery 40% = 2 million; loss = 3 million. Net = 9 − 3 = EUR 6.0 million, or 6.0%. The 9.0% option ignores credit loss; 3.0% wrongly subtracts the full 5 million default and credits only part of the interest back... actually 9 − 5 − 1 is not valid; it reflects an arbitrary error.

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