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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

A dealer bank has total assets of $200 billion and equity of $5 billion. Management reports gross leverage. If a 2% fall in the market value of assets occurs with no other changes, what is the approximate percentage decline in equity?

Equity falls about 80%. Leverage is 40 times ($200 billion over $5 billion), so a 2% asset decline is a $4 billion loss, which is 80% of the $5 billion equity cushion. High leverage magnifies small asset losses into large equity losses.

  1. A2%
  2. B40%Correct
  3. C80%
  4. D100%

Explanation

Leverage = 200/5 = 40x. A 2% fall in assets equals $4 billion, which is 4/5 = 80% of equity. So the decline is 80%, matching the leverage multiplied by the asset loss (40 x 2%). The 40% option mistakenly uses leverage as a percentage; the 2% ignores leverage.

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