According to Regulation T of the Federal Reserve Board, one may borrow up to 50 percent of the purchase price of securities that can be purchased on margin. Therefore, the margin loan will be $1,500,000 (= $3,000,000 × 50%). The remaining $1,500,000 has to be financed by equity. The leverage ratio is calculated as total assets divided by equity. Therefore, the hedge fund’s leverage ratio is 2.0 (\frac{\`3,000,000}{\1`,500,000}).

Note: By buying on margin, you borrow money from a broker. Margin accounts increase an investor's purchasing power and allow them to use other people's money to increase financial leverage.

Things to Remember

• Margin loans allow investors to borrow money from a broker to purchase securities.
• Regulation T of the Federal Reserve Board sets the maximum amount that can be borrowed on margin at 50% of the purchase price of securities.
• Leverage ratio is calculated as total assets divided by equity, indicating the level of financial leverage used by an investor.
• Buying on margin increases an investor's purchasing power but also increases the risk due to the use of borrowed funds.