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

An insurer shifts 10% of its portfolio from investment-grade public bonds yielding 4.0% to private direct loans yielding 7.0%, with an estimated illiquidity and complexity premium of 1.5% embedded in the loan yield. Assuming the expected credit loss on the loans exceeds that of the bonds by 0.8%, what is the approximate net compensation per unit invested for the additional risks beyond the credit loss?

The net compensation is about 2.2%. The loan yield pickup over bonds is 3.0 percentage points, and subtracting the 0.8% higher expected credit loss leaves 2.2% as payment for illiquidity, complexity and other non-credit-loss risks the insurer now bears.

  1. A0.7%
  2. B1.5%
  3. C2.2%Correct
  4. D3.0%

Explanation

Yield pickup is 7.0% - 4.0% = 3.0%. Subtract the extra expected credit loss of 0.8% to get 2.2%, which is the net compensation for illiquidity, complexity and other risks. Option 0.7% subtracts 1.5% and 0.8% incorrectly from the pickup (3.0-2.3); 3.0% ignores the loss.

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