CFA Level I · CFA Level I Exam · Hedge Funds
A relative value fund earns a 1.5% annual spread on a market-neutral position by using leverage of 8 times its equity capital, and borrowing costs are ignored. The spread then widens against the fund by 0.5% before the position is closed. The fund's loss as a percentage of equity is closest to:
The loss is about 4.0% of equity. A 0.5% adverse spread move applies to assets equal to eight times equity, so the equity loss is 0.5% multiplied by 8. This shows how leverage magnifies small spread changes in relative value strategies.
- A0.5%
- B4.0%Correct
- C12.0%
Explanation
The loss on the position is 0.5% of assets, and assets are 8 times equity. Loss on equity = 0.5% × 8 = 4.0%. The 0.5% choice ignores leverage, and 12.0% wrongly applies leverage to the 1.5% spread.
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