FRM Part II · FRM Exam Part II · Liquidity and Leverage
A dealer holds assets of $500 million with equity of $25 million. Leverage is held constant by adjusting the balance sheet. Assets fall in value by 2%. What is the loss as a percentage of the original equity, and what does it imply for a leverage-targeting investor?
The loss is $10 million on $25 million equity, which is 40% of equity, and a leverage-targeting investor must sell assets after a fall to restore leverage.
- A10%; the investor must sell assets to restore leverageCorrect
- B2%; no action is needed
- C20%; the investor must sell assets to restore leverage
- D20%; the investor can buy assets to restore leverage
Explanation
Leverage = 500/25 = 20. Loss = 2% x 500 = 10, which is 10/25 = 40% of equity. Recompute: 10/25 = 40%, so none of the stated percentages is right unless checked: this item is invalid.
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