Explanation:
Initial Assets = Cash ($100). Equity = $80. Debt = $20.
Initial Leverage = Assets / Equity = 100 / 80 = 1.250.
After taking a long position of $100 in equity using 50% margin:
$50 of its own cash, so remaining free cash = $50.$100 in stock, which becomes an asset.$50 from the broker, increasing debt.New Assets = Free Cash ($50) + Stock ($100) = $150.
New Debt = Bank Debt ($20) + Broker Loan ($50) = $70.
New Equity = Assets - Debt = 150 - 70 = $80 (Equity remains unchanged).
New Leverage = Assets / Equity = 150 / 80 = 1.875. The firm's economic balance sheet leverage changes from 1.250 to 1.875.
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$100 in Cash, $20 in Debt, and Equity of $80. This corresponds to an initial placement of $80 in Equity by the fund's owners plus a loan of $20 by a commercial bank. Assume Lever Brothers finances a long position in $100 worth of an equity at the Reg T margin requirement of 50%. It invests $50 of its own funds and borrows $50 from the broker. Immediately following the trade, its margin account has $50 in equity and a $50 loan from the broker (The broker retains custody of the stock as collateral for the loan). If firm leverage is defined, per Malz, as Assets/Equity, then what is the change in the firm’s economic balance sheet?A
From 1.000 to 1.500
B
From 1.250 to 1.875
C
From 1.250 to 1.500
D
From 1.500 to 1.500
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