Sample exam help!

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karatekid

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hey folks, question on sample exam Q13.
I remember the question says 40% leverage. return of invested assest is 7.4% and cost of borrowed fund is 4.25%.
so the answer should be 9.5%, but it is not in the choices, which really freak me out!
and the anwer used the fomula, it says 7.4%+40/100(7.4%-4.25%)=8.66% assuming $100 invested. but it should be 7.4%+40/60(7.4%-4.25%)=9.5%???
it is borrowed fund/equity not borrowed fund/invested???
can you help???
 
Edit: Sorry kk, terrible explanation on my part.
There are other threads on this. You may want to search.
 
I am nor sure why you are using the 40/60 weight … which is incorrect
7.4% is the return on the invested assets to this add the weighted net return on borrowed funds (0.4*(7.4-4.25)) which will give you the total return
 
but i remember it says “40% of the portfolio is borrowed”. anyone remember how the question is asked?
 
40/100 = 40% of the portfolio borrowed
40/60 = 67% of the portfolio borrowed
(if you assume assets of 60 borrowing would have to be 24)
Right? Maybe I am backwards here.
Also, you can go back and print the answer key and it will show you. Do you have that already? It may not help though.
 
wording was = “average portfolio leverage is 40%”
leverage ratio in most cases = D/A
 
thx, folks.
i think i messed up the % of portfolio or the % of invested fund.
in the answer it says “assume invested asset is $100”. my understanding is that invested fund includes own fund + borrowed fund (see schewer book 3 P182)…
 
thx, RomanZ. if here the ratio is D/A then it should be borrowed fund $40, equity $60, total invested asset $100?
 
The problem is in ambiguous definition of leverage ratio.
I chose the right answer, but my explanation above was incorrect.
In this case leverage ratio is D/E (not D/A)
Fortunately, there was no answer like 9,5 % =)
 
mwvt9 Wrote:
——————————————————-
> 40/100 = 40% of the portfolio borrowed
>
> 40/60 = 67% of the portfolio borrowed
> (if you assume assets of 60 borrowing would have
> to be 24)
>
> Right? Maybe I am backwards here.
>
> Also, you can go back and print the answer key and
> it will show you. Do you have that already? It
> may not help though.
mwvt9: my friend don’t do that. The CFAI answer is wrong or the CFAI text book is wrong ( CFAI, volume 4, page 100). they clearly define leverage as D/E and in this problem they define leverage as D/A. I know that both could be considered as leverage BUT for this SS, the formula is wrong and confusing as well.
When I saw the way the answer it, I am like what the heck? WTF? why CFAI tries to mess with at this very moment?
They better get ass straight up.
 
tibwa Wrote:
——————————————————-
>
> mwvt9: my friend don’t do that. The CFAI answer is
> wrong or the CFAI text book is wrong ( CFAI,
> volume 4, page 100).
they clearly define leverage
> as D/E and in this problem they define leverage as
> D/A.
I don’t think they do. All they told you was the result of the D/E = 40%. I don’t think they ever said D was 40 or E was 60. You could have chosen any amount of E you wanted, but D/E had to equal 40%.
I think you are assuming D = 40 because D/E is 40%. But I don’t think you can make that assumption.
In other words since D/E = Leverage and you are given leverage then 40%= X/Whatever number you want to use. If you say E is 60 then D has to be 24. If you say E is 100 then D has to be 40.
I can’t fully recall the details though so I could be off.
 
mwvt9 Wrote:
——————————————————-
> tibwa Wrote:
> ————————————————–
> —–
> >
> > mwvt9: my friend don’t do that. The CFAI answer
> is
> > wrong or the CFAI text book is wrong ( CFAI,
> > volume 4, page 100).
>
> they clearly define leverage
> > as D/E and in this problem they define leverage
> as
> > D/A.
>
> I don’t think they do. All they told you was the
> result of the D/E = 40%. I don’t think they ever
> said D was 40 or E was 60. You could have chosen
> any amount of E you wanted, but D/E had to equal
> 40%.
>
> I think you are assuming D = 40 because D/E is
> 40%. But I don’t think you can make that
> assumption.
>
> In other words since D/E = Leverage and you are
> given leverage then 40%= X/Whatever number you
> want to use. If you say E is 60 then D has to be
> 24. If you say E is 100 then D has to be 40.
>
> I can’t fully recall the details though so I could
> be off.
I do agree with you on this BUT i am comfuse by the fact that they clearly say in the answer that “Assuming total invested amount of $100”. If $100 is invested and leverage is 40%, i would assumed D = 40 E= 60 and D+E =100
do you see my point? Check it out again. Dude the method just freak me out.
 
I just took a look back at the answer and it does seem wrong. My apologies to tibwa.
I don’t remember what the question itself said and I can only see the explanation. If it read assuming 100 E then it would make sense.
 
mwvt9 Wrote:
——————————————————-
> I just took a look back at the answer and it does
> seem wrong. My apologies to tibwa.
>
> I don’t remember what the question itself said and
> I can only see the explanation. If it read
> assuming 100 E then it would make sense.
That is correct bro. This is not the first time CFAI mess up answer. They did it last year in Real return calculation question for the mock exam.
 
Evaluate the effects of leverage on portfolio returns.
RP = rF + (B / E) × (rF – k), where RP = portfolio rate of return, where rF = return on funds invested, B = amount of borrowed funds, E = amount of equity, and k = cost of borrowing. Assuming $100 invested, then,
Rp= 7.40% + 40/100 x (7.4% - 4.25%) = 8.66%
From the answer key
 
I have a screenshot of the question, it says:
“Our mandate allows us to borrow between 0 and 75 percent of the equity in our portfolio.
…our average portfolio leverage is 40%.”
Now you can stick to the way CFAi defined leverage in one example in the book, but the truth is everyone refers to different metrics when they are defining leverage (D/A or D/E). This requires you to look to the question or other clarification for guidance. I felt the question was clear on this, I viewed it as D/A. Didn’t stop be from BOMBING the sample having read just under half the material so far.
 
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