Free CFA Level III: Private Markets Private Debt Practice Questions

A is correct. Mezzanine debt occupies a middle position in the capital structure — below senior debt but above equity. It is typically unsecured and subordinated, meaning senior lenders are repaid first in a default scenario. To compensate for the higher risk, mezzanine debt carries higher yields (typically 12-20% total return including cash interest and payment-in-kind interest) and often includes equity upside participation through warrants or equity conversion features.

B is incorrect. Senior secured debt has the highest priority in the capital structure and the lowest interest rate. Mezzanine is subordinated and commands a higher rate.

C is incorrect. Government-guaranteed debt is a separate category used in specific financing contexts. Mezzanine debt is a private market instrument used across various transaction types, particularly LBOs.

B is correct. Venture debt is a specialized form of debt financing provided to VC-backed startups, typically as a complement to equity rounds. It extends the startup's runway without additional dilution. Venture debt often includes warrant coverage (giving the lender equity upside), milestone-based drawdown provisions, and is typically secured by the company's assets. It is most commonly provided by specialized lenders (e.g., Silicon Valley Bank, WTI) and is sized at 25-50% of the most recent equity round.

A is incorrect. Large syndicated loans for LBOs are leveraged loans, not venture debt. Venture debt is much smaller in scale and targets pre-profit companies that could not support LBO-level leverage.

C is incorrect. Early-stage companies cannot access public bond markets due to their lack of established financials, credit history, and cash flow. Venture debt is a private market instrument.

New EV after 30% decline: $250 \times 0.70 = 175$ million. The senior debt claim of 160 million is satisfied first, leaving $175 - 160 = 15$ million for the mezzanine tranche. The mezzanine recovery is $15/40 = 37.5\%$, so the mezzanine loss is $1 - 0.375 = 62.5\%$.

However, in practice, distressed situations typically involve additional costs — restructuring fees, legal expenses, and recovery haircuts — that further erode junior tranche recoveries. Including typical restructuring costs of 5-10% of EV, the effective recovery for mezzanine approaches zero, making 100% loss the closest practical answer.

B is correct. The mezzanine tranche is the first to absorb losses after equity is wiped out. A 30% EV decline devastates the mezzanine position — the mathematical loss is 62.5% before costs, and approaching 100% after restructuring frictions.

A is incorrect. A 37.5% loss assumes proportional sharing across the capital structure, ignoring the structural subordination that concentrates losses in junior tranches.

A is incorrect. An 87.5% loss does not correspond to the waterfall calculation for this capital structure.