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CFA Level I · CFA Level I Exam · Equity Issuance and Trading

An investor buys shares on margin. Compared with buying the same shares entirely with her own cash, the use of margin most likely:

Buying on margin magnifies both gains and losses on the investor's equity, because borrowed funds raise the position size relative to her own capital. It does not reduce exposure, and it guarantees nothing, since interest costs and falling prices can erode or reverse the return.

  1. Areduces the investor's exposure to the share price
  2. Bmagnifies both potential gains and potential losses on her equityCorrect
  3. Cguarantees a higher return whenever the share price rises

Explanation

Borrowing to buy more shares than cash alone would allow increases exposure to price changes, so percentage gains and losses on the investor's own equity are both magnified. Margin does not reduce exposure. A higher return is not guaranteed because interest costs must be paid and the price may fall.

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