FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks
A dealer bank has total assets of USD 500 billion and shareholders' equity of USD 20 billion. Its securities inventory of USD 300 billion is financed by repo. Its leverage ratio (assets/equity) is closest to:
Leverage equals total assets divided by equity, so 500 divided by 20 gives 25. The repo-financed inventory of 300 is only part of the assets and is the wrong numerator, so a figure of 15 would understate the dealer's balance sheet leverage.
- A15
- B20
- C25Correct
- D40
Explanation
Leverage = total assets / equity = 500/20 = 25. Using the repo-financed inventory of 300 as the numerator gives 15, which uses the wrong base. Check: 20 x 25 = 500.
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