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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

Orange County's pool had about $7.5 billion of equity capital from investors and borrowed roughly $12.5 billion via reverse repos to buy securities, for total assets of about $20 billion. If asset values fall 5% with no change in borrowings, what percentage of the investors' original equity is lost?

The equity loss is 13.3%. A 5% fall on $20 billion of assets is $1.0 billion, and dividing by $7.5 billion of equity gives 13.3%, which equals the 5% decline times leverage of about 2.67.

  1. A5.0%
  2. B8.0%
  3. C13.3%
  4. D20.0%Correct

Explanation

Loss = 5% x $20 billion = $1.0 billion. Relative to $7.5 billion equity, that is 13.3%. Check: leverage is 20/7.5 = 2.67, and 5% x 2.67 = 13.3%. Wait, recompute: 1.0/7.5 = 13.3%, so the key is 13.3%.

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