CFA Level I · CFA Level I Exam · Investments in Private Capital: Equity and Debt
An investor in a private debt fund asks why private debt typically offers an illiquidity premium. The most appropriate response is that private debt:
Private debt offers an illiquidity premium because it generally lacks a liquid secondary market like that of public bonds, so investors cannot easily sell. Compensation for this limited exit ability is demanded, while covenants and default risk do not explain the premium.
- Ais usually unrated and cannot carry covenants
- Bgenerally has no secondary market comparable to public bondsCorrect
- Calways has lower default risk than public bonds
Explanation
Private loans are negotiated, bespoke and seldom traded, so investors demand extra return for limited liquidity. Private loans often carry strong covenants, and they are not always lower in default risk.
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