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FRM Part II · FRM Exam Part II · The Rise and Risks of Private Credit

An interval fund invests in illiquid private loans but offers investors quarterly redemptions up to 5% of assets. In a stress period, redemption requests reach 12% of assets. Which statement best describes the key risk?

The risk is liquidity mismatch between quarterly redemption rights and illiquid loans. When requests exceed the 5% limit, the fund must prorate redemptions, sell loans at discounts or borrow, which can harm remaining investors. Seniority or par marks do not provide cash.

  1. ALiquidity mismatch: the fund must gate, sell assets at discounts, or draw on lines, which can disadvantage remaining investorsCorrect
  2. BNo risk arises because loans are senior secured
  3. CThe mismatch is eliminated by marking loans at par
  4. DRedemption requests above the limit must be fully paid by the manager's capital

Explanation

The fund offers periodic liquidity against illiquid assets. When requests exceed capacity, it prorates redemptions (gates) or sells assets at discounts, imposing costs on remaining investors. Seniority does not create liquidity, and marking at par does not generate cash.

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