LOS a: Evaluate the effects of leverage on portfolio returns.

Q1. Which of the following statements regarding leverage is FALSE?

A)   Leverage is beneficial only when the strategy earns a return greater than the cost of borrowing.

B)   A leverage-based strategy decreases portfolio returns when the return on the strategy is greater than the cost of borrowed funds.

C)   Leverage refers to using borrowed funds to purchase a portion of the securities in the portfolio.

Q2. Which of the following is an advantage of leverage? Leverage:

A)   magnifies the return from a security for a given price change.

B)   decreases the risk for a given return potential.

C)   increases the return potential without incurring larger risk.

Q3. Which of the following best characterizes leveraging? Leveraging involves:

A)   exploiting mispricings in the market.

B)   borrowing funds to implement a trade.

C)   writing options.

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Q1. Which of the following statements regarding leverage is FALSE?

A)   Leverage is beneficial only when the strategy earns a return greater than the cost of borrowing.

B)   A leverage-based strategy decreases portfolio returns when the return on the strategy is greater than the cost of borrowed funds.

C)   Leverage refers to using borrowed funds to purchase a portion of the securities in the portfolio.

Correct answer is B)

A leverage-based strategy increases, not decreases portfolio returns when the return on the strategy is greater than the cost of borrowed funds.

Q2. Which of the following is an advantage of leverage? Leverage:

A)   magnifies the return from a security for a given price change.

B)   decreases the risk for a given return potential.

C)   increases the return potential without incurring larger risk.

Correct answer is A)

Leveraging increases the return potential but also increases the risk, resulting in a wider range of possible outcomes.

Q3. Which of the following best characterizes leveraging? Leveraging involves:

A)   exploiting mispricings in the market.

B)   borrowing funds to implement a trade.

C)   writing options.

Correct answer is B)

Leverage refers to the use of borrowed funds to purchase a portion of the securities in a portfolio. A leverage-based strategy is used with the objective of earning a return over and above the cost of borrowed funds.

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