Question on Levered Returns *Spoiler*

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LanceTX

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On question 13 of sample exam 1, can somebody help explain why my numbers aren’t working out?
The average return on the portfolio is 7.4%, 40% leverage, 4.25% repo rate. Just working it all the way out with an example is not yielding the same result as the formula and I can’t seem to figure out why…
If I invest $100 into bonds earning 7.4%, after one year that will make 7.40. Since I’m using leverage on 40% then I pay (40*.0425)= 1.70. My total return is 5.70.
5.70/60(equity)= 9.5%
The formula comes up with 8.66%.
 
60*1.074 = 64.44
Return on my invested capital = 4.44/60 = 7.4%
Return on my borrowed capital = (40*1.074%) - 40 = 2.96
Return on total capital = (4.44 + 2.96 - 1.7) / 60 = 9.5%
What gives?
 
jmychasi Wrote:
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> 7.4+[0.4*(7.4-4.25)] = 8.66%
I know how to do this formula, but why does it not reconcile with my example.
 
The explanation of their answer is flawed because it indicated that the amount INVESTED was $100. This was actually the amount of equity.
It said the portfolio was levered at 40%, meaning D/E=40% (at least that is what they were looking for).
This has been discussed a couple of times now. You may want to go back and search it.
BTW, where you been all year Lance?
 
I’ve been around… not studying as much this year as last year because I’ve just been so busy with everything. I’ve had like 4 weddings/bachleor parties to go to, so this is my first weekend in a long time I’ve been able to study. I’ll be off all this week so i’m going to hit it hard.
 
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