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CFA Level I · CFA Level I Exam · Investments in Private Capital: Equity and Debt

Which feature of a typical direct lending loan to a middle-market borrower most likely reduces the investor's exposure to rising interest rates?

A floating reference rate plus a fixed spread most likely reduces exposure to rising rates, because the coupon resets with the benchmark. Fixed long-maturity coupons stay unchanged, and PIK interest with a bullet repayment defers cash and adds credit risk rather than reducing rate sensitivity.

  1. AFloating reference rate plus a fixed spreadCorrect
  2. BFixed coupon with a long maturity
  3. CPayment-in-kind interest with a bullet repayment

Explanation

A floating base rate resets coupons as rates rise, limiting price and income sensitivity to rate changes. Fixed long-maturity coupons do not reset. PIK interest accrues and increases credit exposure rather than reducing rate risk, though floating loans raise borrower default risk when rates climb.

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