Explanation:
Before the trade, this is how the hedge fund's balance sheet looks like:
Assets
Cash: 1,000,000
Liabilities
Equity: 1,000,000
After the trade, here's the hedge fund's balance sheet:
Assets
Cash: 500,000
Stocks: 1,000,000
Liabilities
Equity: 1,000,000
Margin loan: 500,000
The leverage ratio (LR) is equal to total assets divided by equity.
LR = 1,500,000 / 1,000,000 = 1.5
Things to Remember
Regulation T specifies the amount of credit brokers-dealers may extend to investors for the purchase of securities and also sets forth regulations for the use of cash accounts. A margin account is required for investors who wish to purchase securities with broker-dealer credit. Under Reg T, investors may borrow a maximum of 50% of the purchase price and must pay the remaining balance in cash.
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Q.3880 A hedge fund has $1,000,000 in cash, corresponding to an initial placement of $1,000,000 in equity by its owners. The hedge fund wants to finance a long position $1,000,000 worth of stocks at the Reg T margin requirement of 50 percent. A broker facilitates the trade by lending the hedge fund $500,000. Determine the new leverage ratio for the hedge fund.
A
0.5
B
1.0
C
2.0
D
1.5