Free CFA Level III: Private Markets Private Special Situations Practice Questions

B is correct. In a loan-to-own strategy, the investor purchases distressed debt (typically at a significant discount to face value) with the strategic objective of becoming a majority equity owner of the reorganized company. Through the bankruptcy or restructuring process, debt claims at the fulcrum level are converted to equity. The investor's discounted purchase price effectively becomes their cost basis for the equity position.

A is incorrect. Lending to healthy companies at premium rates describes direct lending or opportunistic credit, not a loan-to-own strategy. Loan-to-own specifically targets distressed situations.

C is incorrect. Lending to management for a buyout describes a management buyout (MBO) financing, not a loan-to-own strategy. Loan-to-own involves purchasing existing distressed debt in the secondary market, not originating new loans.

A is correct. A credit bid is a powerful tool available to secured creditors in bankruptcy auctions. It allows the secured lender to bid for the debtor's assets using the face value of their debt claim as currency, rather than cash. For example, a lender owed 100 million in secured debt can submit a credit bid of up to 100 million without spending cash. This effectively converts their debt position into an equity (ownership) position in the acquired assets. Credit bidding is a key mechanism for loan-to-own strategies.

B is incorrect. While third parties can bid with cash, the credit bid is specifically a right of secured creditors to use their claims as consideration, which is a unique advantage.

B is incorrect. Management cannot use employment contracts as bidding currency. Credit bids are exclusively for creditors with valid secured claims against the debtor's assets.

A is correct. In a reorganization, value available for unsecured creditors = Reorganization value - Senior secured claims = 350 - 200 = 150 million. Total unsecured claims = 250 million. Recovery rate = 150/250 = 60%.

Unsecured creditors would receive new securities (new debt, equity, or a combination) in the reorganized company totaling approximately 60% of their face value claims. This is significantly better than liquidation, where total value is only 150 million — just enough to cover senior secured debt with nothing remaining for unsecured creditors.

B is incorrect. While the 60% recovery figure is correct, the reasoning that "reorganization value exceeds total claims" is wrong. Total claims = 200 + 250 = 450 million, which exceeds the 350 million reorganization value. The company is still insolvent.

B is incorrect. In a reorganization (not liquidation), unsecured creditors receive value because the going-concern value (350) exceeds senior claims (200), leaving 150 million for unsecured holders.