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

A risk manager at a large asset owner is assessing whether growing institutional demand for private credit could amplify financial stability risks. Which observation would most strongly indicate a vulnerability linked to search-for-yield inflows?

The strongest warning sign is rapid inflows alongside tighter spreads and weaker covenants, combined with redeemable investor vehicles holding illiquid loans. Yield-chasing capital erodes underwriting discipline and creates liquidity mismatch, which can amplify stress if investors redeem.

  1. ARapid fund inflows coincide with narrowing spreads and weaker loan covenants, while investors hold redeemable vehicles backed by illiquid loansCorrect
  2. BPrivate credit funds are funded mainly by long-lockup capital with no leverage and strong covenants
  3. CSpreads on private loans widen as inflows slow and underwriting standards tighten
  4. DInvestors diversify across many managers with staggered lockups and low redemption rights

Explanation

Strong inflows chasing yield compress spreads and loosen underwriting, while redeemable structures against illiquid assets create liquidity mismatch. The other options show stable funding or tighter discipline, which reduce vulnerability.

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