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

Because most private credit loans are floating rate, how does a rapid rise in policy rates primarily alter the risk profile of a direct lending fund compared with a fixed-rate bond fund?

Floating-rate lending lowers the fund's duration and price sensitivity, but the higher base rate raises borrowers' debt service costs and default risk. Interest rate risk is thus converted into credit risk rather than eliminated, and illiquidity remains.

  1. AMarket price (duration) risk falls, but borrower credit risk from higher debt service burden risesCorrect
  2. BBoth market price risk and borrower credit risk fall
  3. CInterest rate risk rises sharply while credit risk is eliminated by the floating coupon
  4. DLiquidity risk disappears because loans reprice at each reset

Explanation

Floating coupons reset, so duration is low and the fund's price sensitivity is small. However, higher base rates raise borrowers' interest burden and can lower coverage ratios, transferring interest rate risk into credit risk. Credit risk is not removed, and repricing does not create liquidity.

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