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FRM Part II · FRM Exam Part II · The Global Drivers of Private Credit

A risk manager assesses how a prolonged period of higher policy rates affects a direct lending fund's risk profile. Which is the most likely consequence, holding other factors constant?

Higher policy rates raise the interest burden of floating-rate borrowers, lowering coverage and increasing default risk. The lender's interest rate risk is thereby transformed into credit risk. Lack of mark-to-market does not remove the underlying economic deterioration.

  1. ALower market-to-market volatility but higher borrower default rates as every loan is fixed rate
  2. BHigher interest burden on floating-rate borrowers, raising default risk and shifting rate risk to credit riskCorrect
  3. CReduced credit risk because lenders' interest income rises on fixed-rate assets
  4. DNo change in credit risk because private loans are not marked to market

Explanation

Most private credit loans are floating rate, so higher rates raise borrower interest costs and reduce coverage, converting interest rate risk for the lender into credit risk. Option 0 wrongly assumes fixed rates; option 2 ignores that floating loans reset; option 3 confuses valuation with economic risk.

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