FRM Part II · FRM Exam Part II · Liquidity and Leverage
A hedge fund has equity of $50 million and total assets of $400 million. Its assets fall in value by 3% with no change in liabilities. What is the percentage loss on the fund's equity?
The fund's equity falls 24%. Leverage is 400 divided by 50, or 8 times, so a 3% fall in assets equals a $12 million loss, which is 24% of $50 million in equity. Leverage multiplies asset returns, positively or negatively, onto equity.
- A3%
- B8%
- C24%Correct
- D12%
Explanation
Leverage = 400/50 = 8x. Asset loss = 0.03 x 400 = $12 million. Equity loss = 12/50 = 24%, or 8 x 3%. The 3% ignores leverage; 12% is a wrong multiple (4x); 8% is the leverage multiple itself.
Did you get it right without looking?
One question tells you little. A timed set on Liquidity and Leverage shows your real accuracy, how long you take and where you lose marks.
More Liquidity and Leverage questions
- A regulator observes that a bank's leverage ratio is procyclical: leverage rises in booms and falls in busts as measured by market-value bal…
- A hedge fund has equity of $100 million and total assets of $400 million. The assets earn 6% for the year and borrowing costs 3% on the $300…
- A fund has USD 30 million of equity and holds assets financed with a repo haircut of 6%, running at the maximum leverage the haircut permits…
- A trading desk holds 200 million of securities financed in repo at a 4% haircut. The lender raises the haircut to 10% during market stress, …
- A portfolio earns an unlevered return of 3%, below the 4% cost of borrowing. If the manager increases leverage (assets/equity) from 2 to 3, …
- A bank's repo desk observes that haircuts on a given asset class rise sharply whenever market volatility increases. Which consequence best d…