Free CAIA Level I Private Debt Practice Questions
Private credit on CAIA Level I covers direct lending, mezzanine financing, distressed debt, asset-backed securities (ABS), insurance-linked securities (ILS), structured credit products, and credit derivatives.
Sample Questions
Question 1
Easy
Mortgage REITs primarily generate income by:
Solution
D is correct.
Mortgage REITs (mREITs) invest in mortgage-backed securities or directly in mortgage loans. They typically use leverage to amplify the net interest margin, which is the spread between the yield earned on their mortgage assets and the cost of their short-term borrowings.
Mortgage REITs (mREITs) invest in mortgage-backed securities or directly in mortgage loans. They typically use leverage to amplify the net interest margin, which is the spread between the yield earned on their mortgage assets and the cost of their short-term borrowings.
Question 2
Medium
Milestone-based lending in venture debt most commonly involves:
Solution
A is correct.
Milestone-based lending structures the loan disbursement in tranches that are released as the borrower achieves specified milestones, such as revenue targets, product development goals, or securing additional equity funding. This reduces the lender's risk by ensuring capital is deployed only as the company demonstrates progress.
Milestone-based lending structures the loan disbursement in tranches that are released as the borrower achieves specified milestones, such as revenue targets, product development goals, or securing additional equity funding. This reduces the lender's risk by ensuring capital is deployed only as the company demonstrates progress.
Question 3
Hard
During the 2007-2008 financial crisis, model risk in CDOs was most severely exposed by:
Solution
C is correct.
The Gaussian copula model, which was the industry standard for pricing CDO tranches, assumes that the dependence structure between defaults follows a normal (Gaussian) distribution. This distribution has thin tails, meaning it assigns very low probability to scenarios where many assets default simultaneously. During the crisis, defaults clustered far beyond what the model predicted because real-world default dependence exhibits tail dependence (extreme co-movement during stress) that the Gaussian copula cannot capture. This caused catastrophic losses in tranches that had been rated investment grade.
The Gaussian copula model, which was the industry standard for pricing CDO tranches, assumes that the dependence structure between defaults follows a normal (Gaussian) distribution. This distribution has thin tails, meaning it assigns very low probability to scenarios where many assets default simultaneously. During the crisis, defaults clustered far beyond what the model predicted because real-world default dependence exhibits tail dependence (extreme co-movement during stress) that the Gaussian copula cannot capture. This caused catastrophic losses in tranches that had been rated investment grade.