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

A sponsor acquires a firm for 500 using 60% debt financing from a private credit lender at a floating rate of SOFR plus 6.00%, with SOFR at 4.00%. The firm's EBITDA is 80 and interest is the only fixed charge. By how much does the interest coverage ratio (EBITDA/interest) fall if SOFR rises by 2.00 percentage points, compared with the initial level?

Debt is 300, so initial interest at 10% is 30 and coverage is 80/30, about 2.67. After SOFR rises 2 points the rate is 12%, interest is 36 and coverage is 80/36, about 2.22. Floating-rate borrowing therefore reduces coverage materially.

  1. AFrom 2.67 to 2.22Correct
  2. BFrom 2.67 to 2.00
  3. CFrom 2.67 to 2.50
  4. DFrom 2.00 to 1.67

Explanation

Debt = 0.6 x 500 = 300. Initial rate = 10%, interest = 30, coverage = 80/30 = 2.67. After shock rate = 12%, interest = 36, coverage = 80/36 = 2.22. The option of 2.00 wrongly uses a higher rate of 13.3%; 2.50 uses a rate rise of only 1 point (interest 32).

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