How do interest rate changes affect PE returns?
An advanced Private Equity question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
Higher rates: (1) increase borrowing costs (reduces FCF for deleveraging), (2) reduce leverage capacity (banks lend less at higher rates), (3) compress entry multiples (higher discount rates = lower valuations). A 200bps rate increase on a 5x levered deal can reduce IRR by 2-4%. PE funds hedge through: fixed-rate debt, interest rate caps (cost: 1-2% upfront), or variable-rate with floors.
WHAT INTERVIEWERS LISTEN FOR
- ✓Higher rates increase borrowing costs
- ✓Reduces leverage capacity
- ✓Compresses entry multiples
- ✓IRR impact of 2-4% per 200bps
- ✓Hedging with fixed-rate debt or caps
COMMON MISTAKES
- ✗Ignoring leverage impact on returns
- ✗Assuming no hedging strategies
- ✗Confusing nominal vs real rates
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