Explanation

The leverage ratio is calculated as:

Leverage Ratio = 1 / Initial Margin Requirement

Given:

• Initial margin requirement = 40% = 0.40

Calculation: Leverage Ratio = 1 / 0.40 = 2.50

Why this is correct:

1. When purchasing on margin, the initial margin requirement represents the percentage of the total investment that must be funded with the investor's own capital.
2. With a 40% margin requirement, the investor contributes 40% and borrows 60%.
3. The leverage ratio measures how much total investment can be controlled per unit of equity.
4. For every $1 of equity, the investor can control $2.50 worth of securities ($1/0.40 = $2.50).

Alternative calculation:

• Total investment = 100%
• Equity contribution = 40%
• Leverage = Total investment / Equity = 100% / 40% = 2.5

Verification of other options:

• Option A (1.50): This would correspond to a margin requirement of 66.67% (1/1.50)
• Option B (1.67): This would correspond to a margin requirement of 60% (1/1.67)

Therefore, with a 40% initial margin requirement, the maximum leverage ratio is 2.50.