A private-credit return needs a loss assumption
Series XIX-A case study · set 2, case 2 of 5 · 4 questions · 1 mark each
Question 1 of 4Case practice
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The case · stays here for all 4 questions
A private-credit fund proposes a one-year ₹10 crore loan. The borrower promises a 12% simple cash interest payment at year-end plus repayment of principal. The credit team uses two illustrative outcomes: a 90% chance of full contractual payment, and a 10% chance of default. In default, the fund receives only ₹6 crore of recovered principal at year-end and no interest. These are assumed probabilities, not predictions or statutory parameters. The loan has no additional fees or costs in this exercise. The distributor is comparing the promised coupon with the probability-weighted outcome, and must also explain why a contractual repayment obligation does not remove the possibility of a capital loss.
Both outcomes settle exactly one year after the loan.
Ignore time-value discounting when computing expected cash here.
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The case and its answers
Every question of this case, with its answer and why each other option is wrong.
A private-credit fund proposes a one-year ₹10 crore loan. The borrower promises a 12% simple cash interest payment at year-end plus repayment of principal. The credit team uses two illustrative outcomes: a 90% chance of full contractual payment, and a 10% chance of default. In default, the fund receives only ₹6 crore of recovered principal at year-end and no interest. These are assumed probabilities, not predictions or statutory parameters. The loan has no additional fees or costs in this exercise. The distributor is comparing the promised coupon with the probability-weighted outcome, and must also explain why a contractual repayment obligation does not remove the possibility of a capital loss.
Both outcomes settle exactly one year after the loan.
Ignore time-value discounting when computing expected cash here.
Q1What cash is received in the full-payment outcome?
Option A. ₹12.00 crore
Why it is wrong: This applies a 20% return rather than 12%.
Option B. ₹11.20 crore — Correct answer
Option C. ₹1.20 crore
Why it is wrong: This includes interest but omits principal repayment.
Option D. ₹10.12 crore
Why it is wrong: This treats 12% as ₹0.12 crore rather than 12% of ₹10 crore.
Answer: B. Full payment is ₹10 crore + 12% × ₹10 crore = ₹11.20 crore. It is the contractual good-outcome cash, not the probability-weighted expectation. Remember: A promised coupon describes a contractual payment.
Hint, shown before you answer in practice mode: Add one year’s simple interest to principal.
XIXA-S2-C02-Q1easynumerical
Q2What is the expected year-end cash under the two supplied outcomes?
Option A. ₹8.60 crore
Why it is wrong: This takes a simple average instead of using the stated probabilities.
Option B. ₹10.68 crore — Correct answer
Option C. ₹11.20 crore
Why it is wrong: This ignores the assumed default outcome.
Option D. ₹10.08 crore
Why it is wrong: This includes only the weighted full-payment outcome.
Answer: B. Expected cash = 90% × ₹11.20 crore + 10% × ₹6 crore = ₹10.68 crore. Both the missed interest and incomplete principal recovery affect the result. Remember: Expected cash depends on probabilities and recoveries.
Hint, shown before you answer in practice mode: Weight each cash outcome by its stated probability.
XIXA-S2-C02-Q2mediumnumerical
Q3What is the expected simple return on the original ₹10 crore?
Option A. 10.68%
Why it is wrong: This mistakes expected cash for a percentage return.
Option B. 12.00%
Why it is wrong: This is the promised coupon before considering default.
Option C. 6.80% — Correct answer
Option D. 0.68%
Why it is wrong: This omits conversion of the return ratio to a percentage.
Answer: C. Expected simple return = (₹10.68 crore − ₹10 crore) ÷ ₹10 crore × 100 = 6.80%. This is an illustration using the assumed two-outcome model, not a guaranteed yield. Remember: Separate promised yield from expected return.
Hint, shown before you answer in practice mode: Subtract the original investment before dividing by it.
XIXA-S2-C02-Q3mediumnumerical
Q4What principal loss occurs if the default outcome happens?
Option A. ₹4 crore — Correct answer
Option B. ₹6 crore
Why it is wrong: This is recovered principal, not the amount lost.
Option C. ₹1.20 crore
Why it is wrong: This is missed contractual interest, not principal loss.
Option D. ₹0 crore
Why it is wrong: The passage assumes only ₹6 crore of the ₹10 crore principal is recovered.
Answer: A. Principal loss in default = ₹10 crore − ₹6 crore = ₹4 crore. The missed ₹1.20 crore of interest is additional foregone income and is not part of this principal-loss question. Remember: Distinguish recovery, principal loss and missed income.
Hint, shown before you answer in practice mode: Compare principal lent with principal recovered.
XIXA-S2-C02-Q4easynumerical
Reading the documents behind a verbal promise
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