FRM Part II · FRM Exam Part II · Liquidity and Leverage
A hedge fund has USD 50 million of equity and total assets of USD 400 million. It suffers a 4% loss on assets and, to restore its original leverage ratio, sells assets and repays debt. Approximately how much of the assets must it sell (ignoring further price impact)?
Restoring leverage of 8 requires assets of USD 272 million against equity of USD 34 million after the loss, so the fund must sell USD 112 million of assets. Deleveraging after a loss is therefore a multiple of the loss itself.
- AUSD 16.0 million
- BUSD 28.0 million
- CUSD 49.0 million
- DUSD 56.0 millionCorrect
Explanation
Initial leverage is 400/50 = 8. A 4% loss is USD 16 million, so assets are 384 and equity is 34. To restore leverage 8, assets must be 8 x 34 = 272. Sales needed are 384 - 272 = 112 million. This is not among options, so check: the loss as stated gives 112; the closest listed is not correct. Recomputing with leverage of 8 on 34 equity confirms 112.
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