Page 11 - FINAL CFA SLIDES DECEMBER 2018 DAY 13

Session Unit 13:
44. Market Structure & organisation

1. The leverage ratio
= 1 / 0.40 = 2.5; Or 100%/40% = 2.2

2 Investor Return on Margin Transaction (ROE)
Right Now:
• Total buy price = 1,000 × $100 = $100,000
• Initial margin = 40% × $100,000 = $40,000
• Margin loan = = $60,000
• Total initial equity investment = $40,050
• Commission buy = 1,000 × $0.05 = $50
tanties

1 Year latter:
•
• Gain = $9,950 + $2,000 – $2,400 – $50 = $9,500
= 23.72%.
ROE = $9,500 / $40,050
Investor’s ROE < Asset total return
• Price appreciation = 10%

• Dividend = 2%
• Total = 12%

Calculate (1) the leverage ratio and (2) the investor’s * Leverage ratio (=2.5 ) = 30%
return on the margin transaction (return on equity)
if the stock is sold at the end of one year. Because of the loan interest and commissions.

TI: Initial outflow = $40,000 (initial margin) + $50 (purchase commission) = $40,050. first year inflow = $110,000 (stock value) +
$2,000 (dividends) – $60,000 (margin repayment) – $2,400 margin interest – $50 sale commission = $49,550:
CF = –40,050; CF = 49,550; CPT IRR = 23.72%.
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