Financial Risk Manager Part 2

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Explanation:

Debt = $16 × 0.60 = $9.6 million
Leverage ratio = $\frac{\text{total assets}}{\text{equity}}$
leverage ratio = $\frac{16}{(16 - 9.6)} = 2.5$ times

$r^e = Lr^a − (L − 1)r^d$

Where:
$r^a$ = return on assets
$r^e$ = return on equity
$r^d$ = cost of debt
L = leverage ratio

Return on equity = $2.5 \times 11% - [(2.5 - 1)(7%)] = 27.5% - 10.5% = 17%$

Explanation:

Debt = $16 × 0.60 = $9.6 million
Leverage ratio = $\frac{\text{total assets}}{\text{equity}}$
leverage ratio = $\frac{16}{(16 - 9.6)} = 2.5$ times

$r^e = Lr^a − (L − 1)r^d$

Where:
$r^a$ = return on assets
$r^e$ = return on equity
$r^d$ = cost of debt
L = leverage ratio

Return on equity = $2.5 \times 11% - [(2.5 - 1)(7%)] = 27.5% - 10.5% = 17%$

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Q.3230 Abraham Maslow is an equity strategist at FinteeseCapital. He intends to use leverage to increase the returns on a convertible arbitrage strategy. The expected return on assets of the strategy is 11%. The fund has `$16` million invested in the strategy and will finance the investment with 60% borrowed funds. The cost of borrowing is 7%. Using this information, the return on equity (ROE) is closest to:

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Last updated: July 5, 2026 at 07:08

17%

13.66%

10.66%

11%