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

A risk manager reviews a private credit fund whose borrowers are mostly highly levered, sponsor-owned middle-market firms with floating-rate loans. Central banks have sharply raised policy rates. Which risk is most directly heightened for this portfolio?

The most directly heightened risk is borrower credit deterioration. Floating-rate loans reset to higher coupons when policy rates rise, which cuts interest coverage for highly levered middle-market borrowers and raises default probability, even though the lender's nominal income increases.

  1. ADeterioration in borrower interest coverage, raising default riskCorrect
  2. BFixed-rate duration losses from rising yields on the loans
  3. CReduced credit risk because coupons reset higher
  4. DCurrency mismatch between loan coupons and fund capital

Explanation

Floating-rate coupons reset higher, which raises borrowers' interest burden and lowers coverage ratios, increasing default risk. Duration loss is small for floating loans. Higher coupons do not reduce credit risk, and nothing indicates a currency mismatch.

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