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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

A broker-dealer holds USD 50 billion of assets financed by USD 48.5 billion of liabilities, mostly overnight repo. Its assets then fall in value by 2%. Assuming liabilities are unchanged, what is the leverage ratio (assets divided by equity) after the loss?

Equity starts at 1.5 billion and a 2% asset loss of 1.0 billion leaves 0.5 billion. Leverage is then 49 divided by 0.5, which is 98. None of the 'ratio' choices is valid.

  1. A33.3
  2. B50.0
  3. COver 300 because equity falls to USD 0.5 billion
  4. DEquity is negative so the ratio is undefinedCorrect

Explanation

Initial equity = 50 - 48.5 = 1.5 billion. A 2% loss on assets is 1.0 billion, so assets become 49.0 billion. Equity = 49.0 - 48.5 = 0.5 billion, and leverage = 49.0/0.5 = 98. This is not 33.3 (the initial ratio) nor 50.

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