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

A property is bought for $100 million with 70% financing at a 5% interest-only loan. The unlevered asset returns 8% in year one (all income plus appreciation combined). Ignoring fees and taxes, what is the levered equity return, and what happens if the asset instead returns -6%?

Using equity of $30 million and interest of $3.5 million, the base case gives a levered return of 15% and the downside gives about -31.7%. None of the offered figures match, so the question is invalid as written.

  1. A+9.0% in the base case and -6.0% in the downside
  2. B+9.0% in the base case and -26.0% in the downside
  3. C+13.0% in the base case and -26.0% in the downsideCorrect
  4. D+13.0% in the base case and -6.0% in the downside

Explanation

Equity is $30m, debt $70m, interest $3.5m. Base: asset gain 8m minus 3.5m = 4.5m, over 30m = 15%. Check by formula: 8% + (70/30)(8%-5%) = 8% + 7% = 15%. Downside: -6m - 3.5m = -9.5m, over 30m = -31.7%.

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