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FRM Part II · FRM Exam Part II · Liquidity and Leverage

A bank reports total assets of USD 500 billion and shareholders' equity of USD 25 billion. Which of the following correctly gives its accounting leverage ratio (assets to equity) and the implied effect of a 2% fall in asset value on equity, ignoring any other changes?

Leverage is assets divided by equity, 500/25 = 20x. A 2% decline in assets equals USD 10 billion, which is 40% of the USD 25 billion equity, because leverage magnifies asset losses onto the equity base by a factor of 20.

  1. ALeverage of 20x; equity falls by 40%Correct
  2. BLeverage of 20x; equity falls by 2%
  3. CLeverage of 25x; equity falls by 50%
  4. DLeverage of 5%; equity falls by 40%

Explanation

Leverage = 500/25 = 20x. A 2% asset fall is USD 10 billion, which is 10/25 = 40% of equity. Option B ignores the leverage multiplier; option C uses the wrong ratio.

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