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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A CTA fund holds USD 200 million of equity and posts USD 30 million as margin and collateral for futures positions with a notional of USD 600 million. What is the notional-to-equity leverage, and what does it imply about margin-to-equity as a risk indicator?

Notional leverage is 600 divided by 200, or 3.0x, while margin-to-equity is 30 divided by 200, or 15%. Margin-to-equity understates economic leverage because futures margin is small relative to notional exposure, so risk should be judged by notional exposure and volatility, not margin usage.

  1. A3.0x; margin-to-equity of 15% understates leverage because notional exposure is much larger than marginCorrect
  2. B0.15x; margin-to-equity of 3% overstates leverage
  3. C3.0x; margin-to-equity of 30% fully captures leverage
  4. D6.67x; margin-to-equity of 15% equals leverage

Explanation

Notional leverage = 600/200 = 3.0x. Margin-to-equity = 30/200 = 15%. Margin reflects exchange requirements, not market risk, so it understates the exposure; a 1% move in notional is USD 6 million, or 3% of equity. Option 3 computes margin/equity wrongly; option 4 divides equity by margin.

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