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

A risk officer notes that most private credit borrowers are mid-sized firms with floating-rate loans. After a sharp rise in policy rates, which risk is most directly heightened for these borrowers and thus for lenders?

Higher policy rates raise the interest cost on floating-rate private credit loans, lowering borrowers' interest coverage and increasing default risk. Lenders therefore face higher credit losses, rather than the duration losses that would affect fixed-rate holdings.

  1. AReinvestment risk from loans being prepaid early at par
  2. BInterest coverage deterioration leading to higher default riskCorrect
  3. CFixed-coupon duration losses on the lenders' loan books
  4. DReduced need for covenant monitoring due to higher yields

Explanation

Floating-rate debt resets upward with policy rates, raising borrowers' interest burden and lowering interest coverage ratios. This raises default probability for leveraged mid-sized firms. Duration losses apply to fixed-rate holdings, not floating-rate loans.

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