CFA Level I · CFA Level I Exam · Returns of Financial Assets and Instruments
An investor buys a stock using 40,000 of her own money and 60,000 borrowed at 5% annual interest. At year end the stock is worth 108,000 and no dividends were paid. The investor's leveraged return on her own equity is closest to:
The leveraged return is 12.5%. The position gained 8,000 on 100,000, but borrowing cost 3,000 of interest, leaving 5,000 of profit on the investor's 40,000 of equity. That is a 12.5% return on her own capital.
- A8.0%
- B12.5%Correct
- C15.0%
Explanation
Gain on the position = 108,000 - 100,000 = 8,000. Interest = 60,000 x 5% = 3,000. Net gain = 5,000. Return on equity = 5,000/40,000 = 12.5%. The 8.0% figure is the unleveraged return, and 15.0% omits the interest on 40,000 base incorrectly (6,000/40,000).
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